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Showing papers in "Financial Markets and Portfolio Management in 2012"


Journal ArticleDOI
TL;DR: In this paper, the authors review the state of empirical asset pricing devoted to understanding cross-sectional differences in average rates of return and survey both methodologies and empirical evidence, concluding that "tremendous progress has been made in understanding return patterns" and "there is a need to synthesize the huge amount of collected evidence".
Abstract: I review the state of empirical asset pricing devoted to understanding cross-sectional differences in average rates of return. Both methodologies and empirical evidence are surveyed. Tremendous progress has been made in understanding return patterns. At the same time, there is a need to synthesize the huge amount of collected evidence.

131 citations


Journal ArticleDOI
TL;DR: In this article, the authors extend the results of Fung et al. with an augmented version of the Fung and Hsieh (Financ. Anal. 60:65-80, 2004a; J. Finance 18:547-569, 2004b) model to document performance characteristics from January 2005 to December 2010.
Abstract: Using a comprehensive data set of funds-of-hedge funds, we extend the results of Fung et al. (J. Finance 63:1777–1803, 2008) (FHNR) with an augmented version of the Fung and Hsieh (Financ. Anal. J. 60:65–80, 2004a; J. Empir. Finance 18:547–569, 2004b) model to document performance characteristics from January 2005 to December 2010. We find that our sample period is divided into three distinct subperiods: January 2005 to June 2007 (pre-subprime crisis); July 2007 to March 2009; and April 2009 to December 2010 (post-credit crunch) during which the average fund of hedge funds delivered positive alpha only in the first subperiod. We divide the funds of hedge funds sample into those who have alpha and the rest, which we call beta-only. The empirical results show a dramatic decline in the population of alpha producing funds of hedge funds post 2008 compared to the FHNR findings. When we repeat our analysis with a synthetic hedge fund index replicator, we find qualitatively similar results.

29 citations


Journal ArticleDOI
TL;DR: In this article, the impact of public information on trading and market fragmentation in FTSE 100 stocks on the LSE and on Chi-X, the largest multilateral trading facility in Europe, was investigated.
Abstract: This paper studies the impact of public information on trading and market fragmentation in FTSE 100 stocks on the LSE and on Chi-X, the largest multilateral trading facility in Europe. We proxy daily public information through newswire messages, which we differentiate by their ex-ante sentiment. Traders spend a considerable amount of money on subscriptions to newswires and these newswires are the source of much of the real-time public information they receive. We find that overall liquidity decreases as a result of daily negative public information and that it does not change on positive days. Generally, there is a strong increase in trading activity on days with public information. On both positive and negative days, private information shifts from Chi-X to the LSE. Informed trading resorts to the LSE when there are high levels of public information. The shift to the LSE is driven by a decrease of private information on Chi-X on positive days and by an increase in private information on the LSE on negative days. Altogether, we find asymmetric reactions to public information and public information effects on market fragmentation. Our study confirms the important role that public information plays in finding the efficient price in equity markets.

24 citations


Journal ArticleDOI
TL;DR: In this paper, the effect of estimation errors on the outcomes of two recently proposed asset allocations, the equally weighted risk contribution (ERC) and the principal component analysis (PCA) portfolio, is investigated.
Abstract: Since the subprime crisis, portfolios based on risk diversification are of great interest to both academic researchers and market practitioners. They have also been employed by several asset management firms and their performance appears promising. Since they do not rely on estimates of expected returns, they are assumed to be robust. The same argument holds for minimum variance and equally weighted portfolios. In this paper, we consider a Monte Carlo simulation, as well as an empirical global portfolio dataset, to study the effect of estimation errors on the outcomes of two recently proposed asset allocations, the equally weighted risk contribution (ERC) and the principal component analysis (PCA) portfolio. The ERC portfolio is more robust to changes in the input parameters and has a smaller estimation error than the Markowitz approaches, whereas the PCA portfolio is even more unstable than the classical approaches. In the worst-case scenario, neither approach delivers what it promises. However, in every case the resulting return–risk relationship is dominated by the Markowitz approaches.

23 citations


Journal ArticleDOI
TL;DR: In this paper, the authors consider the sources of systemic gains, losses and risks associated with SIFIs in historical context, in the theoretical and empirical literature, and in public policy discussions.
Abstract: Consolidation has been a fact of life in the wholesale financial services sector, resulting in fundamental change in the financial architecture and public exposure to systemic risk. The underlying drivers include advances in transactions and information technologies, regulatory changes, geographic shifts in growth opportunities, and the rapid evolution of client requirements, which in combination have obliged financial firms to rethink their roles as intermediaries. Moreover, financial sector reconfiguration has accelerated as a result of the global market turbulence that began in 2007, with governments either forcing or encouraging combinations of stronger and weaker financial firms in an effort to stem the crisis and improve systemic robustness. In the process, financial firms that are “systemic” in nature and had a major role in creating the crisis have come out of it with even larger market shares and greater systemic importance. Given the episodic socialization of risk in the form of widespread use of public guarantees to firms judged too big or too interconnected to be allowed to fail, the role of systemically important financial institutions (SIFIs) is central to the financial architecture and the public interest going forward. This survey paper considers the sources of systemic gains, losses and risks associated with SIFIs in historical context, in the theoretical and empirical literature, and in public policy discussions—i.e., what is gained and what is lost as a result of the available policy options to deal the dominant role of SIFIs in the financial architecture?

23 citations


Journal ArticleDOI
TL;DR: Duffie et al. as discussed by the authors studied the behavior of participants in decentralized OTC markets and studied the effects on asset prices and returns, and provided a valuable framework for the analysis of how information is transmitted and how asset prices behave over time.
Abstract: In response to the financial crisis of 2007 to 2009, a large number of financial assets, such as derivatives, collateralized debt obligations, and repurchase agreements, which are traded in over-the-counter markets (OTC) are receiving increasing attention A key feature of OTC market is its decentralized nature, that is, agents negotiate prices with each other, often pairwise, and thereby may be uninformed of prices currently traded elsewhere in the OTC market In this opaque market, the bargaining game between market participants can be complex due to different levels of private information and various sets of outside opportunities As a result, agents have difficulty assessing the prices and risks of OTC instruments and thus the investment behavior in OTC markets has intensified the financial crises Some regulatory steps have been taken by the US and European governments to increase competition and transparency in the OTC markets (eg, Dodd–Frank Act in the United States) In this context, Darrell Duffie is a key contributor to the promising new research area of OTC markets, which is relatively undeveloped compared with literature on central market mechanisms Dark Market provides an introduction to the topic and gives an overview of different asset pricing models in OTC markets characterized by symmetric and asymmetric information Duffie seeks to understand and model the behavior of participants in decentralized markets and study the effects on asset prices and returns He also provides a valuable framework for the analysis of how information is transmitted and how asset prices behave over time He explains key concepts and modeling techniques for search and random matching in economies with numerous agents The book is divided into a more theory-oriented main part and an appendix that provides further methodological support for the more advanced

21 citations


Journal ArticleDOI
TL;DR: The authors examined the link between scheduled Federal Open Market Committee (FOMC) meetings and the VIX measure, and found that VIX declines significantly on scheduled meeting dates Unlike prior studies suggesting that the drop in VIX is mechanical, they attribute the decline to the resolution of uncertainty regarding future interest rates provided by the meetings.
Abstract: We examine the link between scheduled Federal Open Market Committee (FOMC) meetings and the VIX measure Our results indicate that VIX declines significantly on scheduled meeting dates Unlike prior studies suggesting that the drop in VIX is mechanical, we attribute the decline to the resolution of uncertainty regarding future interest rates provided by the meetings We examine returns to investable positions on VIX Though a decline in the VIX level commonly occurs on FOMC meeting dates, we find that significant returns may still be garnered from taking short-VIX positions in derivative markets, even after accounting for the bid-ask spread

12 citations


Journal ArticleDOI
TL;DR: In this paper, the authors analyzed the contribution of hedge funds to optimal asset allocations between 1993 and 2010 and found that allocations to hedge funds improved the global minimum variance portfolio even after controlling for short-selling restrictions and minimum diversification constraints.
Abstract: This paper analyzes the contribution of hedge funds to optimal asset allocations between 1993 and 2010 The preferences of specific institutional investors are captured by implementing a Bayesian asset allocation framework that incorporates heterogeneous expectations regarding hedge fund alpha Mean-variance spanning tests are used to infer the ability of hedge funds to significantly enhance the mean-variance efficient frontier Further, a novel democratic variance decomposition procedure sheds light on the dynamics in the co-movement of hedge fund returns with a set of common benchmark assets The empirical findings indicate that portfolio benefits of hedge funds are time-varying and strongly depend on investor optimism regarding hedge funds’ ability to generate alpha In general, allocations to hedge funds improve the global minimum variance portfolio even after controlling for short-selling restrictions and minimum diversification constraints However, due to dynamics underlying the composition of the aggregate hedge fund universe, the factor structure of hedge fund returns has become more similar to the benchmark assets over time

9 citations


Journal ArticleDOI
TL;DR: In this paper, the initial short-term and long-term excess returns for foreign initial public offering (IPO) and seasoned equity offering (SEO) American depository receipts (ADRs) listed on the New York stock exchange from 1990 to 2009 are tested to determine differences in performance based on type of issue and date of issue for the decades of the 1990s and the 2000s.
Abstract: The initial short-term (21-day) and long-term (3-year) excess returns for foreign initial public offering (IPO) and seasoned equity offering (SEO) American depository receipts (ADRs) listed on the New York stock exchange from 1990 to 2009 are tested to determine differences in performance based on type of issue and date of issue for the decades of the 1990s and the 2000s. The overall sample outperformed the SP however, SEO ADRs outperformed IPO ADRs by nearly 19 % (relative to the market index). Breaking IPO and SEO ADR returns down by decade of issue shows that those listed in the 2000s for both samples drastically outperformed those listed in the 1990s in the long term. Both samples of ADRs listed in the 2000s also significantly outperformed the S&P 500 index in the first 36 months of trading. In the short-term results, for the first 21 days of trading, the SEO ADRs significantly outperformed the market by 2.1 %, while IPO ADRs outperformed by 0.97 % (though not significant).

7 citations


Journal ArticleDOI
TL;DR: In this article, the authors identify the core events that trigger the release of analysts' reports on companies that constitute the Dow Jones EuroSTOXX50 index during the three-year period from 2004 to 2006.
Abstract: In order to fulfill their function as information intermediaries in capital markets, sell-side equity analysts regularly issue updated forecasts on the stocks they cover. Quite often, the publication of (revised) analysts’ reports is subject to certain trigger events such as the publication of annual figures or the announcement of an upcoming merger. In this exploratory study, we develop a two-step procedure to identify the core events that trigger the release of analysts’ reports on companies that constitute the Dow Jones EuroSTOXX50 index during the three-year period from 2004 to 2006. These can be grouped into Financial Disclosures, Corporate Management, Corporate Strategy, Business Activity, Operating Environment and Share. The results suggest that sell-side analysts attach great importance to non-financial information events when transforming their earnings estimates into valuation forecasts and stock recommendations. Additionally, we link the information events identified as reasons of issuance to the summary measures disclosed in the reports in order to investigate the relationship between the report trigger and associated analyst reaction. Our findings indicate that the forecasting activity of sell-side analysts is greatly influenced by forward-looking statements made by management, strategy-related news flow, and non-company-specific information relating to the covered firm’s operating environment.

7 citations


Journal ArticleDOI
TL;DR: In this paper, the authors identify positive risk premia for option-implied idiosyncratic risk and show that the compensation of unsystematic risk is mainly driven by firms with high positive implied skewness.
Abstract: A recent strand in the literature has investigated the relationship between idiosyncratic risk and future stock returns. Although several authors have found significant predictive power of idiosyncratic volatility, the magnitude and direction of the dependence is still being debated. Using a sample of all S&P 100 constituents, we identify positive risk premia for option-implied idiosyncratic risk. Depending on the model used to identify unsystematic risk, we observe a statistically and economically significant average annual premium of 1.72 percent. To investigate whether this impact is driven by the definition of idiosyncratic risk, we extend the pricing kernel by implied skewness. Using a double-sorting procedure, we show that the compensation of unsystematic risk is mainly driven by firms with high positive implied skewness.

Journal ArticleDOI
TL;DR: In this paper, the authors examined the stock price reactions of four Swiss banks to negotiations between Switzerland and the European Union and between Swiss and the United States to obtain an estimate of the value of banking secrecy to Swiss banks, and distinguish between tax evasion and genuine privacy concerns as sources of that value.
Abstract: We examine the stock price reactions of four Swiss banks to negotiations between Switzerland and the European Union and between Switzerland and the United States to (i) obtain an estimate of the value of banking secrecy to Swiss banks, and (ii) distinguish between tax evasion and genuine privacy concerns as sources of that value. We find that the value of banking secrecy to the private banks is large, accounting for 8 to 14% of their market value; in contrast, the value of banking secrecy to the universal banks is small. We further find that tax evasion may be less important and privacy concerns more important a source of value of banking secrecy than might previously have been thought.


Journal ArticleDOI
TL;DR: In this article, the authors investigated whether there is a link between momentum profitability and firm ratings and found that firm ratings momentum strategies can even earn positive profits, larger than naive momentum, supporting the firm ratings can be used to strengthen naive momentum effects.
Abstract: This paper investigates whether there is a link between momentum profitability and firm ratings. We follow traditional and practical (non-) investment-grade classifications to divide into three rating groups, high, median, and non investment-grade group (HIG, MIG, and NIG) since firm ratings express risk in relative rank order to contain valuable information. This study considers the US and Taiwanese stock markets. We find that firm ratings momentum strategies can even earn positive profits, larger than naive momentum, supporting that firm ratings can be used to strengthen naive momentum effects. By comparisons, the US firm ratings momentum with NIG produces larger profits than HIG but opposite in direction and V-shaped pattern in Taiwan. With an examination of crises on firm ratings momentum, we find that firm ratings momentum indeed helps increase the payoff during (non-)crises although firm ratings momentum profits should be strong following non-crises states and weak following crises states. However, firm ratings momentum profits partially result from the predictability of business cycle, calendar months, and information asymmetries. Our results highlight the critical importance of using firm ratings screens in empirical momentum studies.

Journal ArticleDOI
TL;DR: In this article, the authors show that any objective risk measurement algorithm mandated by central banks for regulated financial entities will result in more risk being taken by those financial entities than would otherwise be the case.
Abstract: We show that any objective risk measurement algorithm mandated by central banks for regulated financial entities will result in more risk being taken by those financial entities than would otherwise be the case. Furthermore, the risks taken by the regulated financial entities are far more systemically concentrated than they would have been otherwise, making the entire financial system more fragile. This result leaves three options for the future of financial regulation: (1) continue regulating by enforcing risk measurement algorithms at the cost of occasional severe crises, (2) regulate more severely and subjectively by fully nationalizing all financial entities, or (3) abolish all central banking regulations, including deposit insurance, thus allowing risk to be determined by the entities themselves and, ultimately, by their depositors through voluntary market transactions, rather than by the taxpayers through enforced government participation.

Journal ArticleDOI
TL;DR: In this article, the predictive ability of individual analyst target price changes for post-event abnormal stock returns within each recommendation category was studied, and it was shown that the change in target price does not cause abnormal returns.
Abstract: We study the predictive ability of individual analyst target price changes for post-event abnormal stock returns within each recommendation category. Although prior studies generally demonstrate the investment value of target prices, we find that target price changes do not cause abnormal returns within each recommendation level. Instead, contradictory analyst signals (e.g., strong buy reiterations with large target price decreases) neutralize each other, whereas confirmatory signals reinforce each other. Further, our analysis reveals that large target price downgrades can be explained by preceding stock price decreases. However, upgrades are not preceded by stock price increases, thereby demonstrating asymmetric analyst behavior when adjusting target prices to stock prices. Our results suggest that investors should treat recommendations with caution when they are issued with large contradictory target price changes. Thus, instead of blindly following a recommendation, investors might put more weight on the change in the corresponding target price and consider transaction costs.

Journal ArticleDOI
TL;DR: In this article, a risk assessment using an optimal portfolio in which the weights are functions of latent factors and firm-specific characteristics (hereafter, diffusion index portfolio) is presented.
Abstract: We study risk assessment using an optimal portfolio in which the weights are functions of latent factors and firm-specific characteristics (hereafter, diffusion index portfolio). The factors are used to summarize the information contained in a large set of economic data and thus reflect the state of the economy. First, we evaluate the performance of the diffusion index portfolio and compare it to both that of a portfolio in which the weights depend only on firm-specific characteristics and an equally weighted portfolio. We then use value-at-risk, expected shortfall, and downside probability to investigate whether the weights-modeling approach, which is based on factor analysis, helps reduce market risk. Our empirical results clearly indicate that using economic factors together with firm-specific characteristics helps protect investors against market risk.

Journal ArticleDOI
TL;DR: In this paper, the authors argue that the strong member states of the European Currency Union are hostages of a financially distressed member state so that they are compelled to provide financial support, and due to the dynamics of the interaction game, a debt relief is a free lunch for the distressed country.
Abstract: This paper argues that the strong member states of the European Currency Union are hostages of a financially distressed member state so that they are compelled to provide financial support. Moreover, due to the dynamics of the interaction game, a debt relief is a free lunch for the distressed country. This fosters moral hazard of distressed countries. In the absence of capital market control, European politics do not effectively monitor fiscal politics of member states. The lack of a long-term strategy of the European Currency Union to deal with distressed states has undermined the credibility of politics. This lack is also explained by a lack of a European Insolvency Charter. A viable Union requires such a charter with rules for handling distress. Moreover, politics should determine a mechanism to coordinate politics and capital markets in their monitoring of fiscal and economic policy of member states.


Journal ArticleDOI
TL;DR: In this paper, the authors investigate the dependence of equilibrium on the biased business sentiment and a prudential policy instrument (a convex dependence of bank capital requirements on the quantity of uncollateralized credit).
Abstract: I model a number of imperfections in financial intermediation that have implications for real economic activity in a production economy with technological risk. Partially opaque firms are financed by both debt and insider equity. Banks have market power over borrowers. There can be a prior bias in public beliefs about aggregate productivity (business sentiment). I investigate the dependence of equilibrium on the biased business sentiment and a prudential policy instrument (a convex dependence of bank capital requirements on the quantity of uncollateralized credit). Loss given default can be reduced by both a monetary restriction and a macroprudential restriction. Real implications of both are very similar in the aggregate, but macroprudential policies are more advantageous for bank earnings. On the other hand, the policies considered here are unable to reduce the number of defaulting firms (default frequency). Economic activity is highly sensitive to “leaning against the wind” actions on both fronts, so that using a macroprudential instrument to intervene against an asset price bubble has tangible welfare costs comparable to those of a monetary restriction. The costs can be offset by fine tuning capital charges as a function of corporate governance on the borrower side (specifically, by discouraging limited liability of borrowing firm managers).


Journal ArticleDOI
TL;DR: In this article, the authors analyzed spread ladder swaps traded by Deutsche Bank to several medium-size companies and municipalities and found that the derivative was originated at a negative market value of −90,000 to −115,000 euros (depending on the number of factors used in the model).
Abstract: This article analyzes spread ladder swaps traded by Deutsche Bank to several medium-size companies and municipalities. The value of these contracts is highly sensitive to correlations between forward rates. For a contract that was challenged by the medium-size company Ille at the Federal Court of Germany, it turns out that the derivative was originated at a negative market value of −90,000 to −115,000 euros (depending on the number of factors used in the model). Moreover, the model correctly predicts the range for the terminal payment after an adverse development of the term structure of approximately 567,000 euros. We also investigate a product feature that limits the upside potential from the viewpoint of the customer and show that it has a substantial impact on market values. According to the judgment handed down by the court, the bank should have informed the customer about the market value of the product in light of special circumstances. This raises questions as to which products must meet this requirement. Moreover, especially for exotic contracts, market prices are mostly model prices: for spread ladder swaps, substantially different prices are obtained even when investors agree on the variance/covariance matrix but disagree on the number of factors to apply in an implementation of a model.