Traditional exchange rate models are based on differences in macroeconomic fundamentals. However, despite being well grounded in economic theory they have a rather poor out-of sample forecasting record. This empirical failure may be a result of the overly restrictive choice of macroeconomic fundamentals. We suggest using the empirical sovereign yield spread level and slope as proxies of the market's expectations for current and future fundamentals and find promising results when we investigate the forecasting accuracy of these variables. Using the yield spread level and slope as a set of unobservable fundamentals, our model outperforms traditional exchange rate models for most considered currencies and horizons. It is also superior to a random walk in terms of direction of change forecasts and profitability.
{"title":"Exchange Rates and Unobservable Fundamentals: A New Approach to Out-of-Sample Forecasting","authors":"Dennis Wellmann, S. Trück","doi":"10.2139/ssrn.2760772","DOIUrl":"https://doi.org/10.2139/ssrn.2760772","url":null,"abstract":"Traditional exchange rate models are based on differences in macroeconomic fundamentals. However, despite being well grounded in economic theory they have a rather poor out-of sample forecasting record. This empirical failure may be a result of the overly restrictive choice of macroeconomic fundamentals. We suggest using the empirical sovereign yield spread level and slope as proxies of the market's expectations for current and future fundamentals and find promising results when we investigate the forecasting accuracy of these variables. Using the yield spread level and slope as a set of unobservable fundamentals, our model outperforms traditional exchange rate models for most considered currencies and horizons. It is also superior to a random walk in terms of direction of change forecasts and profitability.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"2 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-10-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127693223","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We use principal component analysis on 55 bilateral exchange rates of 11 developed currencies to identify two important global risk sources in foreign exchange (FX) markets. The risk sources are related to Carry and Dollar but are not spanned by these factors. We estimate the market prices associated with the two risk sources in the cross-section of FX market returns and construct FX market-implied country-specific stochastic discount factors (SDFs). The SDF volatilities are related to interest rates and expected carry trade returns in the cross-section. The SDFs price international stock returns and are related to important financial stress indicators and macroeconomic fundamentals. The first principal risk is associated with the Treasury-EuroDollar (TED) spread, quantities measuring volatility, tail and contagion risks, and future economic growth. It earns a relatively small implied Sharpe ratio. The second principal risk is associated with the default and term spreads and quantities capturing volatility and illiquidity risks. It further correlates with future changes in the long-term interest rate and earns a large implied Sharpe ratio. This paper was accepted by Lauren Cohen, finance.
{"title":"Pricing Risks across Currency Denominations","authors":"T. Maurer, Thuy-Duong Tô, N. Tran","doi":"10.2139/ssrn.2589545","DOIUrl":"https://doi.org/10.2139/ssrn.2589545","url":null,"abstract":"We use principal component analysis on 55 bilateral exchange rates of 11 developed currencies to identify two important global risk sources in foreign exchange (FX) markets. The risk sources are related to Carry and Dollar but are not spanned by these factors. We estimate the market prices associated with the two risk sources in the cross-section of FX market returns and construct FX market-implied country-specific stochastic discount factors (SDFs). The SDF volatilities are related to interest rates and expected carry trade returns in the cross-section. The SDFs price international stock returns and are related to important financial stress indicators and macroeconomic fundamentals. The first principal risk is associated with the Treasury-EuroDollar (TED) spread, quantities measuring volatility, tail and contagion risks, and future economic growth. It earns a relatively small implied Sharpe ratio. The second principal risk is associated with the default and term spreads and quantities capturing volatility and illiquidity risks. It further correlates with future changes in the long-term interest rate and earns a large implied Sharpe ratio. This paper was accepted by Lauren Cohen, finance.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"11 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-07-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124794489","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using two sets of hand-collected survey data, we studied the value-adding activities of venture capitalists (VCs) operating in the weak legal environment of China. VCs exert value-enhancing efforts in addition to monitoring through trust considerations. We identified the effects of three types of trusts, strategic reputation-based (C-trust), knowledge-based (K-trust), and identification-based (I-trust), on a company's performance while investing venture capital in China. We find that the C-trust acts only through increased use of complementary resources to improve a firm's performance. K-trust and I-trust can also stimulate in two other ways by reducing transaction costs and improving team-spirit.
{"title":"Venture Capitalists' Value-Enhancing Activities Under Weak Protection of Law","authors":"Hui Li, Xiaohui Wu, Ying Ye, Qi Zeng","doi":"10.2139/ssrn.2717977","DOIUrl":"https://doi.org/10.2139/ssrn.2717977","url":null,"abstract":"Using two sets of hand-collected survey data, we studied the value-adding activities of venture capitalists (VCs) operating in the weak legal environment of China. VCs exert value-enhancing efforts in addition to monitoring through trust considerations. We identified the effects of three types of trusts, strategic reputation-based (C-trust), knowledge-based (K-trust), and identification-based (I-trust), on a company's performance while investing venture capital in China. We find that the C-trust acts only through increased use of complementary resources to improve a firm's performance. K-trust and I-trust can also stimulate in two other ways by reducing transaction costs and improving team-spirit.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"14 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-01-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132187367","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Adam Butt, M. Donald, F. Foster, S. Thorp, G. Warren
We combine survey data from retirement plan members with information from interviews with plan executives to get both perspectives on who accepts the default plan and default investment option and why. We use a natural experiment in default construction where a new regulatory framework required providers to have stipulated default settings in place by early 2014. We find that not all retirement savings plan members who default at the plan choice stage default at the investment choice stage, and vice versa. Only around one third of the sample say they defaulted twice. While some plan executives describe defaulting members as uninterested in their retirement savings, our results highlight that subjective lack of skill combined with trust in the managing agents are the prime motivations for defaulting, rather than low interest. Plan executives set a high risk exposure in default investment strategies to ensure high wealth growth, but defaulting respondents show a lower appetite for risk than active choosers. The heterogeneity and low skill of members make a case for smart defaults.
{"title":"Delegation, Trust and Defaulting in Retirement Savings: Perspectives from Plan Executives and Members","authors":"Adam Butt, M. Donald, F. Foster, S. Thorp, G. Warren","doi":"10.2139/SSRN.2638998","DOIUrl":"https://doi.org/10.2139/SSRN.2638998","url":null,"abstract":"We combine survey data from retirement plan members with information from interviews with plan executives to get both perspectives on who accepts the default plan and default investment option and why. We use a natural experiment in default construction where a new regulatory framework required providers to have stipulated default settings in place by early 2014. We find that not all retirement savings plan members who default at the plan choice stage default at the investment choice stage, and vice versa. Only around one third of the sample say they defaulted twice. While some plan executives describe defaulting members as uninterested in their retirement savings, our results highlight that subjective lack of skill combined with trust in the managing agents are the prime motivations for defaulting, rather than low interest. Plan executives set a high risk exposure in default investment strategies to ensure high wealth growth, but defaulting respondents show a lower appetite for risk than active choosers. The heterogeneity and low skill of members make a case for smart defaults.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"36 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-07-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114895148","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using a unique dataset we provide new evidence on the significant penalty on client fund performance due to conflicts of interest related to the cross trading (TCT) activities of mutual fund advisers: funds managed by advisers in the top TCT quintile significantly underperform funds managed by advisers in the bottom TCT quintile by 1% per year. Adviser incentives to engage in cross trading are directly related to their opportunities for generating revenues from affiliated trading operations. Additional tests suggest that the significantly higher trading commissions paid by client funds of high-TCT advisers are a major source of their under-performance.
{"title":"Cross Trading by Investment Advisers: Implications for Mutual Fund Performance","authors":"Lorenzo Casavecchia, Ashish Tiwari","doi":"10.2139/ssrn.2022808","DOIUrl":"https://doi.org/10.2139/ssrn.2022808","url":null,"abstract":"Using a unique dataset we provide new evidence on the significant penalty on client fund performance due to conflicts of interest related to the cross trading (TCT) activities of mutual fund advisers: funds managed by advisers in the top TCT quintile significantly underperform funds managed by advisers in the bottom TCT quintile by 1% per year. Adviser incentives to engage in cross trading are directly related to their opportunities for generating revenues from affiliated trading operations. Additional tests suggest that the significantly higher trading commissions paid by client funds of high-TCT advisers are a major source of their under-performance.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"109 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-06-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116273065","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper critically reviews the practice of significance testing in modern finance research. Employing a survey of recently published articles in four top-tier finance journals, we find that the conventional significance levels are exclusively used with little consideration of the key factors such as the sample size, power of the test, and expected losses. We also find that statistically significant results reported in many surveyed papers become questionable, if Bayesian method or revised standards for evidence were instead used. We observe strong evidence of publication bias in favour of statistical significance. We propose that substantial changes be made to the current practice of significance testing in finance research, in order to improve research credibility and integrity.
{"title":"Significance Testing in Empirical Finance: A Critical Review and Assessment","authors":"Jae H. Kim, P. Ji","doi":"10.2139/ssrn.2410049","DOIUrl":"https://doi.org/10.2139/ssrn.2410049","url":null,"abstract":"This paper critically reviews the practice of significance testing in modern finance research. Employing a survey of recently published articles in four top-tier finance journals, we find that the conventional significance levels are exclusively used with little consideration of the key factors such as the sample size, power of the test, and expected losses. We also find that statistically significant results reported in many surveyed papers become questionable, if Bayesian method or revised standards for evidence were instead used. We observe strong evidence of publication bias in favour of statistical significance. We propose that substantial changes be made to the current practice of significance testing in finance research, in order to improve research credibility and integrity.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"29 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-06-08","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122053617","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this study we identify an implicit noise premium in mutual fund advisory fees. We argue that idiosyncratic volatility makes it difficult for investors to estimate fund performance, resulting in investor disagreement about advisory skills. Since mutual fund shares cannot be sold short, the outcome is higher advisory fees than would be the case if advisory skills were transparent to investors. We find empirical support for this argument, in the form of a positive dependence of advisory fees on idiosyncratic volatilities, which is robust to the inclusion of other fund characteristics known to affect advisory compensation. We show that the dependence of advisory fees on idiosyncratic volatilities improves previous estimations of the fee-performance sensitivity for mutual funds. Our findings also reveal that investor sophistication reduces the dependence of advisory compensation on idiosyncratic volatility, since more sophisticated investors are less inclined to reward advisors for generating noisy returns.
{"title":"Are Mutual Fund Investors Paying for Noise?","authors":"Lorenzo Casavecchia, H. Hulley","doi":"10.2139/ssrn.2578547","DOIUrl":"https://doi.org/10.2139/ssrn.2578547","url":null,"abstract":"In this study we identify an implicit noise premium in mutual fund advisory fees. We argue that idiosyncratic volatility makes it difficult for investors to estimate fund performance, resulting in investor disagreement about advisory skills. Since mutual fund shares cannot be sold short, the outcome is higher advisory fees than would be the case if advisory skills were transparent to investors. We find empirical support for this argument, in the form of a positive dependence of advisory fees on idiosyncratic volatilities, which is robust to the inclusion of other fund characteristics known to affect advisory compensation. We show that the dependence of advisory fees on idiosyncratic volatilities improves previous estimations of the fee-performance sensitivity for mutual funds. Our findings also reveal that investor sophistication reduces the dependence of advisory compensation on idiosyncratic volatility, since more sophisticated investors are less inclined to reward advisors for generating noisy returns.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"75 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-03-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126024486","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
R. Brooks, R. Faff, Sirimon Treepongkaruna, Eliza Wu
We investigate the effects of S&P’s sovereign re-ratings on the higher moments of equity market returns over recent financial crises. Using a set of intraday stock market index prices and sovereign credit ratings for a sample of 36 countries which experienced sovereign rating changes over the period from 1996 - 2013, we find that the higher moments of stock market returns are significantly more responsive to sovereign re-ratings during financial crises but the effects on stock markets are not the same across different financial crises. The effects during crises are however magnified for large downgrades and those that are associated with a loss of investment grade status. We find that there are asymmetric effects during financial crises in that downgrades are consistently more significant than upgrades in increasing realized volatility and realized kurtosis. Both upgrades and downgrades affect realized skewness in times of crises in the expected direction.
{"title":"Do Sovereign Re-Ratings Destabilize Equity Markets During Financial Crises?: New Evidence From Higher Return Moments","authors":"R. Brooks, R. Faff, Sirimon Treepongkaruna, Eliza Wu","doi":"10.2139/ssrn.2186275","DOIUrl":"https://doi.org/10.2139/ssrn.2186275","url":null,"abstract":"We investigate the effects of S&P’s sovereign re-ratings on the higher moments of equity market returns over recent financial crises. Using a set of intraday stock market index prices and sovereign credit ratings for a sample of 36 countries which experienced sovereign rating changes over the period from 1996 - 2013, we find that the higher moments of stock market returns are significantly more responsive to sovereign re-ratings during financial crises but the effects on stock markets are not the same across different financial crises. The effects during crises are however magnified for large downgrades and those that are associated with a loss of investment grade status. We find that there are asymmetric effects during financial crises in that downgrades are consistently more significant than upgrades in increasing realized volatility and realized kurtosis. Both upgrades and downgrades affect realized skewness in times of crises in the expected direction.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"16 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-03-05","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"134281254","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper analyses the causal relationship between gold production costs and gold prices using a hand-collected set of country and company data on gold mining. We find strong econometric evidence for causality running from gold prices to gold production costs. The results are supported theoretically by the small amount of annual gold production relative to the total stock and the real options embedded in gold mines. The low flow-stock ratio of gold implies low market power of gold mining firms and thus an inability to significantly influence gold prices. The real options enable gold mining firms to adjust production conditional on the gold price. Production thus follows gold prices.
{"title":"Do Gold Prices Cause Production Costs? Evidence from Country and Company Data","authors":"Fergal O'Connor, D. Baur, B. Lucey","doi":"10.2139/ssrn.2507733","DOIUrl":"https://doi.org/10.2139/ssrn.2507733","url":null,"abstract":"This paper analyses the causal relationship between gold production costs and gold prices using a hand-collected set of country and company data on gold mining. We find strong econometric evidence for causality running from gold prices to gold production costs. The results are supported theoretically by the small amount of annual gold production relative to the total stock and the real options embedded in gold mines. The low flow-stock ratio of gold implies low market power of gold mining firms and thus an inability to significantly influence gold prices. The real options enable gold mining firms to adjust production conditional on the gold price. Production thus follows gold prices.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"82 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-02-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121268426","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Precious metals (gold, silver, and platinum) have become an important part of investment portfolios for individuals as well as for institutions. A key question is whether investors should actively trade these metals to time the market or whether they should take a buy-and-hold strategy. This paper examines the weak-form efficiency of precious metals markets with this question in mind, using the automatic portmanteau and variance ratio tests. It is found that return predictability of these markets has been changing over time, depending on prevailing economic and political conditions. The return predictability of gold and silver markets have been showing a downward trend, implying that the degree of the weak-form efficiency of these markets have been gradually improving. In particular, the gold market has been highly efficient recently, showing the highest degree of market efficiency among the three precious metals markets. The overall evidence suggest an buy-and-hold strategy, but profit opportunities may arise from time to time depending on prevailing economic or political conditions.
{"title":"Will Precious Metals Shine? A Market Efficiency Perspective","authors":"Amélie Charles, Olivier Darné, Jae H. Kim","doi":"10.2139/ssrn.2456799","DOIUrl":"https://doi.org/10.2139/ssrn.2456799","url":null,"abstract":"Precious metals (gold, silver, and platinum) have become an important part of investment portfolios for individuals as well as for institutions. A key question is whether investors should actively trade these metals to time the market or whether they should take a buy-and-hold strategy. This paper examines the weak-form efficiency of precious metals markets with this question in mind, using the automatic portmanteau and variance ratio tests. It is found that return predictability of these markets has been changing over time, depending on prevailing economic and political conditions. The return predictability of gold and silver markets have been showing a downward trend, implying that the degree of the weak-form efficiency of these markets have been gradually improving. In particular, the gold market has been highly efficient recently, showing the highest degree of market efficiency among the three precious metals markets. The overall evidence suggest an buy-and-hold strategy, but profit opportunities may arise from time to time depending on prevailing economic or political conditions.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"41 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2014-06-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114811665","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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