When regressing return on variance, does a low coefficient necessarily indicate low risk-aversion? Considering CAPM tests conditional on investor sentiment, like in Yu and Yuan [2011], we find that the familiar power issue in single-equation CAPM tests is exacerbated when sentiment is high: the expected return is obscured by a higher variance, the predictors of risk exhibit less variation over time, and even more of that variation is noise (attenuation bias). When, following French, Schwert, and Stambaugh [1987], we add the change of risk as a regressor (to control for flight-for-quality effects and obtain 'indirect evidence' of risk aversion) the conclusions of the regression even self-contradict. For a cleaner answer we propose to start, instead, from a Taylor expansion of the stock's price, which induces as regressors the changes in variance, expected earnings, the risk-free rate, and longer-term earnings growth. The coefficient of the change of risk is closer to zero than it is in the extended-CAPM regression, and implies a plausible level RRA. It is also closer to zero when sentiment is high, but this can be fully explained by a lower and shorter-lived predictive power of the proxy conditional on high sentiment; we do not need lower risk aversion to explain this, in short. In fact, the implied point estimate of RRA for high sentiment is higher, not lower.
{"title":"The Risk–Return–Sentiment Nexus: Dealing with Low Power and Big Bias","authors":"M. Doan, P. Sercu","doi":"10.2139/ssrn.3223286","DOIUrl":"https://doi.org/10.2139/ssrn.3223286","url":null,"abstract":"When regressing return on variance, does a low coefficient necessarily indicate low risk-aversion? Considering CAPM tests conditional on investor sentiment, like in Yu and Yuan [2011], we find that the familiar power issue in single-equation CAPM tests is exacerbated when sentiment is high: the expected return is obscured by a higher variance, the predictors of risk exhibit less variation over time, and even more of that variation is noise (attenuation bias). When, following French, Schwert, and Stambaugh [1987], we add the change of risk as a regressor (to control for flight-for-quality effects and obtain 'indirect evidence' of risk aversion) the conclusions of the regression even self-contradict. For a cleaner answer we propose to start, instead, from a Taylor expansion of the stock's price, which induces as regressors the changes in variance, expected earnings, the risk-free rate, and longer-term earnings growth. The coefficient of the change of risk is closer to zero than it is in the extended-CAPM regression, and implies a plausible level RRA. It is also closer to zero when sentiment is high, but this can be fully explained by a lower and shorter-lived predictive power of the proxy conditional on high sentiment; we do not need lower risk aversion to explain this, in short. In fact, the implied point estimate of RRA for high sentiment is higher, not lower.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"42 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-07-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121568727","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}
The optimal factor timing portfolio is equivalent to the stochastic discount factor. We propose and implement a method to characterize both empirically. Our approach imposes restrictions on the dynamics of expected returns which lead to an economically plausible SDF. Market-neutral equity factors are strongly and robustly predictable. Exploiting this predictability leads to substantial improvement in portfolio performance relative to static factor investing. The variance of the corresponding SDF is larger, more variable over time, and exhibits different cyclical behavior than estimates ignoring this fact. These results pose new challenges for theories that aim to match the cross-section of stock returns.
{"title":"Factor Timing","authors":"Valentin Haddad, S. Kozak, S. Santosh","doi":"10.2139/ssrn.2945667","DOIUrl":"https://doi.org/10.2139/ssrn.2945667","url":null,"abstract":"The optimal factor timing portfolio is equivalent to the stochastic discount factor. We propose and implement a method to characterize both empirically. Our approach imposes restrictions on the dynamics of expected returns which lead to an economically plausible SDF. Market-neutral equity factors are strongly and robustly predictable. Exploiting this predictability leads to substantial improvement in portfolio performance relative to static factor investing. The variance of the corresponding SDF is larger, more variable over time, and exhibits different cyclical behavior than estimates ignoring this fact. These results pose new challenges for theories that aim to match the cross-section of stock returns.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-06-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130487525","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 provide a theoretical characterization of international stochastic discount factors (SDFs) in incomplete markets under different degrees of market segmentation. Using 40 years of data on a cross-section of countries, we estimate model-free SDFs and factorize them into permanent and transitory components. We find that large permanent SDF components help to reconcile the low exchange rate volatility, the exchange rate cyclicality, and the forward premium anomaly. However, integrated markets entail highly volatile and almost perfectly comoving international SDFs. In contrast, segmented markets can generate less volatile and more dissimilar SDFs. In quest of relating the SDFs to economic fundamentals, we document strong links between proxies of financial intermediaries' risk-bearing capacity and model-free international SDFs. We interpret this evidence through the lens of an economy with two building blocks: limited participation by households and financiers who face an intermediation friction.
{"title":"Model-Free International Stochastic Discount Factors","authors":"Mirela Sandulescu, F. Trojani, Andrea Vedolin","doi":"10.2139/ssrn.3070739","DOIUrl":"https://doi.org/10.2139/ssrn.3070739","url":null,"abstract":"We provide a theoretical characterization of international stochastic discount factors (SDFs) in incomplete markets under different degrees of market segmentation. Using 40 years of data on a cross-section of countries, we estimate model-free SDFs and factorize them into permanent and transitory components. We find that large permanent SDF components help to reconcile the low exchange rate volatility, the exchange rate cyclicality, and the forward premium anomaly. However, integrated markets entail highly volatile and almost perfectly comoving international SDFs. In contrast, segmented markets can generate less volatile and more dissimilar SDFs. In quest of relating the SDFs to economic fundamentals, we document strong links between proxies of financial intermediaries' risk-bearing capacity and model-free international SDFs. We interpret this evidence through the lens of an economy with two building blocks: limited participation by households and financiers who face an intermediation friction.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"343 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114129031","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}
The paper provides empirical evidence on the effects of ECB conventional and unconventional monetary policy on the euro exchange rate, focusing on the period from January 2013 to September 2017. Innovations to conventional and unconventional monetary policies are identified through changes in, respectively, short- and long-term interest rates immediately after Governing Council meetings. Both types of measures contributed to the depreciation of the euro from mid-2014; surprises associated with conventional measures had a stronger and more persistent effect than those associated with unconventional ones. Time-varying estimates of the effects of conventional surprises since 1999 show that the responsiveness of exchange rates to monetary news increased markedly from 2013. State-dependence analysis finds that the exchange rate became more sensitive to monetary policy when the ECB adopted a policy of negative interest rates and when conventional and unconventional monetary surprises moved in the same direction.
{"title":"ECB Monetary Policy and the Euro Exchange Rate","authors":"Martina Cecioni","doi":"10.2139/ssrn.3176930","DOIUrl":"https://doi.org/10.2139/ssrn.3176930","url":null,"abstract":"The paper provides empirical evidence on the effects of ECB conventional and unconventional monetary policy on the euro exchange rate, focusing on the period from January 2013 to September 2017. Innovations to conventional and unconventional monetary policies are identified through changes in, respectively, short- and long-term interest rates immediately after Governing Council meetings. Both types of measures contributed to the depreciation of the euro from mid-2014; surprises associated with conventional measures had a stronger and more persistent effect than those associated with unconventional ones. Time-varying estimates of the effects of conventional surprises since 1999 show that the responsiveness of exchange rates to monetary news increased markedly from 2013. State-dependence analysis finds that the exchange rate became more sensitive to monetary policy when the ECB adopted a policy of negative interest rates and when conventional and unconventional monetary surprises moved in the same direction.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"57 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-05-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115629830","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}
Pub Date : 2018-05-01DOI: 10.5089/9781484353660.001
Signe Krogstrup, C. Tille
The literature on drivers of capital flows stresses the prominent role of global financial factors. Recent empirical work, however, highlights how this role varies across countries and time, and this heterogeneity is not well understood. We revisit this question by focusing on financial intermediaries' funding flows in different currencies. A portfolio model shows that the sign and magnitude of the response of foreign currency funding flows to global risk factors depend on the financial intermediary's pre-existing currency exposure. Analysis of data on European banks' aggregate balance sheets lends support to the model predictions, especially in countries outside the euro area.
{"title":"Foreign Currency Bank Funding and Global Factors","authors":"Signe Krogstrup, C. Tille","doi":"10.5089/9781484353660.001","DOIUrl":"https://doi.org/10.5089/9781484353660.001","url":null,"abstract":"The literature on drivers of capital flows stresses the prominent role of global financial factors. Recent empirical work, however, highlights how this role varies across countries and time, and this heterogeneity is not well understood. We revisit this question by focusing on financial intermediaries' funding flows in different currencies. A portfolio model shows that the sign and magnitude of the response of foreign currency funding flows to global risk factors depend on the financial intermediary's pre-existing currency exposure. Analysis of data on European banks' aggregate balance sheets lends support to the model predictions, especially in countries outside the euro area.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"44 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-05-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125080229","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}
When real wages in an economy no longer reflect productivity, normally devaluations of the currency restore international price-competitiveness via imported inflation that reduces real wages. This instrument is not available in a currency union. The job has to be done by reductions in nominal wages that are felt as more severe pain than inflation-induced reductions in real wages. To ease this pain a special currency split is proposed: ACT takes over the function as a medium of exchange i.e. for flows but not for stocks. Thus ACT can devaluate while all stocks are not devaluated. When international price-competitiveness is restored and no further devaluation is needed, the currency split ends.
{"title":"Act for Currency Unions","authors":"Gerd Stark-Veltel","doi":"10.2139/ssrn.3113236","DOIUrl":"https://doi.org/10.2139/ssrn.3113236","url":null,"abstract":"When real wages in an economy no longer reflect productivity, normally devaluations of the currency restore international price-competitiveness via imported inflation that reduces real wages. This instrument is not available in a currency union. The job has to be done by reductions in nominal wages that are felt as more severe pain than inflation-induced reductions in real wages. To ease this pain a special currency split is proposed: ACT takes over the function as a medium of exchange i.e. for flows but not for stocks. Thus ACT can devaluate while all stocks are not devaluated. When international price-competitiveness is restored and no further devaluation is needed, the currency split ends.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"27 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-02-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132629884","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}
The purpose of this paper is to investigate if the St Louis Federal Financial Stress Index (STLFSI) can be used to predict the EUR/USD, AUD/USD and CAD/USD. Building on Gurrib (2018) who proposed a unified financial condition index and tested the predictability of the index on major foreign currency markets, this paper extends the analysis further allowing a comparison between the forecasts of the most actively traded currencies, tests for the model efficiency, and analyzes the actual and forecasted foreign currency values of the predicted model. Using weekly data over 1993-2018, and 1-week and 2-weeks ahead forecasts, the EUR/USD had the smallest normalized mean squared errors, with a significant p value of the index and homoscedasticity. Although series were stationary, the results were mixed across different currencies when lags were increased. The forecasted values were higher than the actual foreign currency values during the 2008-2009 crisis, and vice versa during the 2000-2002, explained by the STLFSI spiking up during the 2008-2009 event compared to the 2000-2002 events. The lower and upper band level under the 95% prediction interval, however, captured the effect of the global financial crisis of 2008-2009 and 2000-2002 events.
{"title":"Can the EUR/USD, AUD/USD and CAD/USD Be Predicted Using Financial Stress Index?","authors":"Ikhlaas Gurrib","doi":"10.2139/ssrn.3130538","DOIUrl":"https://doi.org/10.2139/ssrn.3130538","url":null,"abstract":"The purpose of this paper is to investigate if the St Louis Federal Financial Stress Index (STLFSI) can be used to predict the EUR/USD, AUD/USD and CAD/USD. Building on Gurrib (2018) who proposed a unified financial condition index and tested the predictability of the index on major foreign currency markets, this paper extends the analysis further allowing a comparison between the forecasts of the most actively traded currencies, tests for the model efficiency, and analyzes the actual and forecasted foreign currency values of the predicted model. Using weekly data over 1993-2018, and 1-week and 2-weeks ahead forecasts, the EUR/USD had the smallest normalized mean squared errors, with a significant p value of the index and homoscedasticity. Although series were stationary, the results were mixed across different currencies when lags were increased. The forecasted values were higher than the actual foreign currency values during the 2008-2009 crisis, and vice versa during the 2000-2002, explained by the STLFSI spiking up during the 2008-2009 event compared to the 2000-2002 events. The lower and upper band level under the 95% prediction interval, however, captured the effect of the global financial crisis of 2008-2009 and 2000-2002 events.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"55 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-02-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116361807","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}
As cryptocurrencies gain popularity, the issue of how to regulate them becomes more pressing. The attractiveness of cryptocurrencies is due in part to their decentralized, peer-to-peer structure. This makes them an alternative to national currencies which are controlled by central banks. Given that these cryptocurrencies are already replacing some of the “regular” national currencies and financial products, the question then arises: should they be regulated? And if so, how? This paper draws the legal distinction between cryptocurrencies which are in fact currency and those which are securities disguised as currency. It further suggests that in cases where a token is indeed a security, regular securities regulation should apply. In all other cases anti-fraud measures should be in place in order to protect investors. Further regulation should only be put in place if the cryptocurrency starts increasing systemic risk in the general financial system.
{"title":"The Regulation of Cryptocurrencies - Between a Currency and a Financial Product","authors":"Hadar Y. Jabotinsky","doi":"10.2139/ssrn.3119591","DOIUrl":"https://doi.org/10.2139/ssrn.3119591","url":null,"abstract":"As cryptocurrencies gain popularity, the issue of how to regulate them becomes more pressing. The attractiveness of cryptocurrencies is due in part to their decentralized, peer-to-peer structure. This makes them an alternative to national currencies which are controlled by central banks. Given that these cryptocurrencies are already replacing some of the “regular” national currencies and financial products, the question then arises: should they be regulated? And if so, how? This paper draws the legal distinction between cryptocurrencies which are in fact currency and those which are securities disguised as currency. It further suggests that in cases where a token is indeed a security, regular securities regulation should apply. In all other cases anti-fraud measures should be in place in order to protect investors. Further regulation should only be put in place if the cryptocurrency starts increasing systemic risk in the general financial system.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"21 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-02-07","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127828794","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 uses a comprehensive and detailed bank†level data set to study how the divergence of central bank balance sheet policy in the US vis†A †vis the euro area and Japan would affect the supply of international US dollar loans by global banks. Our empirical findings support the view that the contractionary effect of US monetary normalization on global dollar liquidity would be offset by an expansionary effect from continued supply of US dollar loans by euro area and Japanese banks. The net effect, however, is crucially dependent on the stability of global foreign exchange markets and investor perceptions of the default risks of global banks. Our findings show that there could be a significant contraction of the supply of international US dollar loans if and when the US monetary normalization coincides with a dislocation of the FX swap market and a rise of bank default risks. Our results are robust to alternative model specifications and different data sets.
{"title":"Divergent Monetary Policies and International Dollar Credit: Evidence from Bank‐Level Data","authors":"D. He, E. Wong, Kelvin Ho, Andrew Tsang","doi":"10.1111/1468-0106.12255","DOIUrl":"https://doi.org/10.1111/1468-0106.12255","url":null,"abstract":"This paper uses a comprehensive and detailed bank†level data set to study how the divergence of central bank balance sheet policy in the US vis†A †vis the euro area and Japan would affect the supply of international US dollar loans by global banks. Our empirical findings support the view that the contractionary effect of US monetary normalization on global dollar liquidity would be offset by an expansionary effect from continued supply of US dollar loans by euro area and Japanese banks. The net effect, however, is crucially dependent on the stability of global foreign exchange markets and investor perceptions of the default risks of global banks. Our findings show that there could be a significant contraction of the supply of international US dollar loans if and when the US monetary normalization coincides with a dislocation of the FX swap market and a rise of bank default risks. Our results are robust to alternative model specifications and different data sets.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"63 4","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2018-02-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132502472","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 paper, we compare the bitcoin exchange rate of the U.S. dollar against the Euro with the relevant foreign spot exchange rate and find empirical evidence of co-integration and one-way Granger-causality from the spot exchange rate to the bitcoin exchange rate. Furthermore, we find market efficiency in the bitcoin exchange rate.
{"title":"Market Efficiency of the Bitcoin Exchange Rate: Evidence From Co-Integration Tests","authors":"Zheng Nan, T. Kaizoji","doi":"10.2139/ssrn.3179981","DOIUrl":"https://doi.org/10.2139/ssrn.3179981","url":null,"abstract":"In this paper, we compare the bitcoin exchange rate of the U.S. dollar against the Euro with the relevant foreign spot exchange rate and find empirical evidence of co-integration and one-way Granger-causality from the spot exchange rate to the bitcoin exchange rate. Furthermore, we find market efficiency in the bitcoin exchange rate.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"18 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2017-12-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121134305","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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