Margin trade,short sales and financial stability

We model how leveraged trading activities constrained by dynamic funding availability affect financial stability. In the market, customers trade based on the fundamental value of the risky asset and make full payment for their transactions, while speculators take trading position based on margin, which is constantly adjusted by the financier, the fund provider, according to the price volatility. As a result of equilibrium price discontinuity triggered by dynamic margin requirements, trivial shocks to external supply, wealth or fundamental value can be transmitted into asset price crashes or jumps. We find that tightening margin requirements improves (mitigates) the market liquidity in the bull (bear) market, and that imposing short sale constraints helps prevent the price from falling further when the asset is sufficiently under-priced and accelerate price collapse when the asset is over-priced.

     

Oil price shocks and economic growth: The volatility link

This paper shows that oil shocks impact economic growth primarily through the conditional variance of growth. Our comparison of models focuses on density forecasts. Over a range of dynamic models, oil shock measures and data, we find a robust link between oil shocks and the volatility of economic growth. We then develop a new measure of oil shocks and show that it is superior to existing measures; it indicates that the conditional variance of growth increases in response to an indicator of the local maximum oil price exceedance. The empirical results uncover a large pronounced asymmetric response of the growth volatility to oil price changes. The uncertainty about future growth is considerably lower than with a benchmark AR(1) model when no oil shocks are present.     

The macroeconomic impact of economic uncertainty and financial shocks under low and high financial stress

External financial frictions might increase the severity of economic uncertainty shocks. We analyze the impact of aggregate uncertainty and financial condition shocks using a threshold vector autoregressive (TVAR) model with stochastic volatility during distinct US financial stress regimes. We further examine the international spillover of the US financial shock. Our results show that the peak contraction in euro area industrial production due to uncertainty shocks during a financial crisis is nearly-four times larger than the peak contraction during normal times. The US financial shocks have an influential asymmetric spillover effect on the euro area. Furthermore, the estimates reveal that the European Central Bank (ECB) is more cautious in implementing a monetary policy against uncertainty shocks while adopting hawkish monetary policies against financial shocks. In contrast, the Fed adopts a more hawkish monetary policy during heightened uncertainty, whereas it acts more steadily when financial stress rises in the economy.     

Economic policy uncertainty,oil price volatility and stock market returns: Evidence from a nonlinear model

This paper investigates the nonlinear relationship between economic policy uncertainty, oil price volatility and stock market returns for 25 countries by applying the panel smooth transition regression model. We find that oil price volatility has a negative effect on stock returns, and this effect increases with economic policy uncertainty. Furthermore, there is pronounced heterogeneity in responses. First, oil-exporting countries whose economies depend more on oil prices respond more strongly to oil price volatility than oil-importing countries. Second, stock returns of developing countries are more susceptible to oil price volatility than that of developed countries. Third, crisis plays a crucial role in the relation between oil price volatility and stock returns.     

News shocks and asset price volatility in general equilibrium

We study equity price volatility in general equilibrium with news shocks about future productivity and monetary policy. As West (1988) shows, in a partial equilibrium present discounted value model, news about the future cash flow reduces asset price volatility. We show that introducing news shocks in a canonical dynamic stochastic general equilibrium model may not reduce asset price volatility under plausible parameter assumptions. This is because, in general equilibrium, the asset cash flow itself may be affected by the introduction of news shocks. In addition, we show that neglecting to account for policy news shocks (e.g., policy announcements) can potentially bias empirical estimates of the impact of monetary policy shocks on asset prices.     

Economic uncertainty,oil prices,hedging and U.S. stock returns of the airline industry

This paper examines the impacts of economic policy uncertainty and oil price shocks on stock returns of U.S. airlines using both industry and firm-level data. Our empirical approach considers a structural vector-autoregressive model with variables recognized to be important for airline returns including jet fuel price volatility. Empirical results confirm that oil price increase, economic uncertainty and jet fuel price volatility have significantly adverse effect on real stock returns of airlines both at industry and at firm level. In addition, we also find that hedging future fuel purchase has statistically positive impact on the smaller airlines. Our results suggest policy implications for practitioners, managers of airline industry and commodity investors.     

Macroeconomic Uncertainty and Oil Price Volatility

This paper shows that higher macroeconomic uncertainty causes higher oil price volatility. Regimes of low and high uncertainty are identified in a threshold VAR model in which the effects of structural oil demand and supply shocks are estimated. The results show that higher macroeconomic uncertainty, as measured by global industrial production volatility, significantly increases the sensitivity of oil prices to shocks in oil demand and supply. This occurs as uncertainty lowers the price elasticity of oil demand and supply. The difference in the estimated oil price elasticities is economically meaningful as the price impact of a similar change in oil production might double when it hits the economy in uncertain times. As such, varying uncertainty can explain why oil price volatility is typically higher during periods such as financial crises and recessions, and why oil price volatility changes over time more generally.     

Risk shocks and housing supply: A quantitative analysis

This paper analyzes the role of stochastic uncertainty in a multi-sector housing model with financial frictions. We include time varying uncertainty (i.e. risk shocks) in the technology shocks that affect housing production and provide estimates of the time-series properties of risk shocks by using firm level productivity data. The analysis demonstrates that risk shocks to the housing production sector are a quantitatively important impulse mechanism for understanding housing price movements. Specifically, the model can match the volatility of housing prices observed in the data. It is also demonstrated that adjustment costs are important in replicating the contemporaneous correlation of housing prices with GDP and residential investment. Critically, bankruptcy costs act as an endogenous markup factor in housing prices and are an important determinant of house price volatility. However, in comparison to housing demand shocks, risk shocks have low explanatory power for real quantities.     

Modeling dynamic conditional correlations with leverage effects and volatility spillover effects: Evidence from the Chinese and US stock markets affected by the recent trade friction

In this article, we investigate the dynamic conditional correlations (DCCs) with leverage effects and volatility spillover effects that consider time difference and long memory of returns, between the Chinese and US stock markets, in the Sino-US trade friction and previous stable periods. The widespread belief that the developed markets dominate the emerging markets in stock market interactions is challenged by our findings that both the mean and volatility spillovers are bidirectional. We do find that most of the shocks to these DCCs between the two stock markets are symmetric, and all the symmetric shocks to these DCCs are highly persistent between Shanghai’s trading return and S&P 500′s trading or overnight return, however all the shocks to these DCCs are short-lived between S&P 500′s trading return and Shanghai’s trading or overnight return. We also find clear evidence that the DCC between Shanghai’s trading return and S&P 500′s overnight return has a downward trend with a structural break, perhaps due to the “America First” policy, after which it rebounds and fluctuates sharply in the middle and later periods of trade friction. These findings have important implications for investors to pursue profits.     

The transmission of US economic policy uncertainty shocks to Asian and global financial markets

This paper proposes a novel approach to investigating the spillover effects of US economic policy uncertainty shocks on the global financial markets. Employing a factor-augmented vector autoregression (FAVAR), we model US economic policy uncertainty jointly with the latent factors extracted from equity prices, exchange rates, and commodity prices. We find that US economic policy uncertainty affects these factors significantly. A country-level analysis shows heterogeneous responses to an increase in US economic policy uncertainty. With regard to equities, US economic policy uncertainty adversely affects equity prices. However, its impact on the Chinese equity market is relatively small. As for foreign exchange markets, while many currencies depreciate in response to an increase in US economic policy uncertainty, the US dollar and the Japanese yen appreciate, reflecting their safe-haven status. The Chinese yuan, whose nominal exchange rate is closely linked to the US dollar, also appreciates in response to uncertainty shocks.     

Testing the stabilization hypothesis in the UK short-term interest rates: Evidence from a GARCH-X model

The objective of this paper is to examine the validity of one of the recurring arguments made against futures markets that they give rise to price instability. The paper concentrates on the impact of futures trading on the spot market volatility of short-term interest rates. The analytical framework employed is based on a new statistical approach aiming to reconcile the traditional models of short-term interest rates and the conditional volatility processes. More specifically, this class of models aims to capture the dynamics of short-term interest rate volatility by allowing volatility to depend on both scale effects and information shocks. Using a GARCH-X and asymmetric GARCH-X model four main conclusions emerge from the present study. First, the empirical results suggest that there is an indisputable change in the nature of volatility with evidence of mean reversion after the onset of futures trading. Second, the information flow into the market has improved as a result of futures trading. Third, a stabilization effect has been detected running from the futures market to the cash market by lowering volatility levels and decreasing the risk in the spot market. Finally, trying to capture the leverage effect the findings suggest that positive shocks have a greater impact on volatility than negative shocks.     

Monetary policy and stock prices in small open economies: Empirical evidence for the new EU member states

This study presents evidence on the effect of domestic and Euro Area monetary policy on stock prices in four new EU member states of Central Europe and the main determinants of stock price volatility, estimating structural vector autoregressive models identified with short-run restrictions. We find that stock prices in the considered new EU member states are more sensitive to changes in the Euro Area interest rate than to the domestic one. Moreover, the bulk of stock price volatility in these countries is due to shocks related to exchange rate and Euro Area monetary policy. Overall, we find that local stock markets are more sensitive to external shocks than to domestic ones.     

U.S. uncertainty and Asian stock prices: Evidence from the asymmetric NARDL model

When uncertainty reduces spending among U.S. consumers, it may affect the bottom line stock performance of Asian producers that cater to their needs. Theory predicts that the impact of uncertainty will be asymmetrical: during the two phases of the business cycle, countercyclic shocks will outweigh procyclic shocks, resulting in phase-specific equilibrium price adjustments. We conjecture that relative to recessions, recoveries bring larger long-run price adjustments, a response to pent-up growth potential. This is an extension of existing theories, which predict that recoveries bring overshooting, a transient reaction to pent-up demand. We test for these asymmetric uncertainty effects on 11 Asian stock market indices over the 2000M08 – 2017M02 period. Our independent measures include the economic policy uncertainty index (EPU) of Baker, Bloom, and Davis (2016), the Chicago Board Options Exchange implied volatility index (VIX), and the financial uncertainty indicator (JLN) of Jurado, Ng, and Ludvigson (2015). To characterize asymmetry, we employ the nonlinear autoregressive distributed lag (NARDL) model of Shin, Yu, and Greenwood-Nimmo (2014), in which both short- and long-run nonlinearities are captured through positive and negative partial sum decompositions of the explanatory variable(s). Using the NARDL output, we test three hypotheses. The first, that increases in uncertainty (decreases in uncertainty) result in stock price drops (stock price rises), is broadly supported by our analysis. The second, that equilibrium adjustments following negative countercyclic uncertainty shocks exceed those following positive movements, is supported fully by the EPU analysis and partially by the VIX and JLN analyses. The third hypothesis, that recoveries are characterized by overshooting, is consistent only with the behavior of the Chinese stock responses to EPU and VIX shocks. Our results demonstrate the advantages of the NARDL model in characterizing asymmetry. They suggest that while long-run asymmetry is fairly consistent across countries, short-run asymmetry is more country-specific.     

Cross-sectional implications of dynamic asset pricing with stochastic volatility and ambiguity aversion

Building on recent research that highlights the importance of macroeconomic volatility and ambiguity aversion in explaining the dynamics of stock returns, in this paper we propose a dynamic asset pricing model that simultaneously accounts for stochastic macroeconomic volatility and ambiguity, assuming that investors deal with uncertainty about the mechanics of macroeconomic fluctuations using first-release consumption and revisions to aggregate consumption on vintage data. Our results show that the proposed model captures a large fraction of the cross-sectional variation of excess returns for a wide range of market anomaly portfolios. Furthermore, while the price of risk for ambiguity is positive and significant for the vast majority of assets under study, macroeconomic volatility yields ambiguous outcomes, although it significantly increases the explanatory power of the model for specific assets. Our results suggest that macroeconomic volatility and ambiguity complement each other in explaining the cross-sectional behavior of stock returns.     

Global economic policy uncertainty aligned: An informative predictor for crude oil market volatility

This paper constructs an aligned global economic policy uncertainty (GEPU) index based on a modified machine learning approach. We find that the aligned GEPU index is an informative predictor for forecasting crude oil market volatility both in- and out-of-sample. Compared to general GEPU indices without supervised learning, well-recognized economic variables, and other popular uncertainty indicators, the aligned GEPU index is rather powerful and can provide preponderant or complementary information. The trading strategy based on the aligned GEPU index can also generate sizable economic gains. The statistical source of the aligned GEPU index’s predictive power is that it can learn both the magnitude and sign of national EPU variables’ predictive ability and thus yields reasonable and informative loadings. On the other hand, the economic driving force probably stems from the ability for forecasting the shocks of oil-related fundamentals.     

An empirical analysis of the Carbon Financial Instrument

This study provides an empirical investigation of the price volatility—trading volume relationship for the Carbon Financial Instrument (CFI). A CFI is a financial contract that is traded on the Chicago Climate Exchange (CCX) and represents the right to emit 100 metric tons of CO₂ equivalent. CFI contracts differ from one another on the basis of their allocation year to CCX member firms, referred to as their respective Vintage year. We provide evidence indicating a positive contemporaneous relationship between price changes and trading volume for the different CFI Vintage contracts. Employing bivariate VAR models that adjust for trade duration, we find that CFI price volatility and trading volume are persistent across time. Furthermore, we provide evidence indicating that lagged volume increases price volatility, in addition to lagged price volatility increasing trading volume levels in the CCX market. Our results are in agreement with prior research documenting significant positive price volatility—volume relationships in traditional equity markets.     

Dynamic time series momentum of cryptocurrencies

This paper examines the momentum effect for twenty cryptocurrencies compared to the US stock market. For this purpose, we implement a dynamic modeling approach to define and test momentum periods that follow a formation period for interday and various intraday price levels. We find evidence that large proportions of the asset classes’ formation periods are followed by momentum periods, strongly supporting the momentum effect. In particular cryptocurrencies have significantly larger and longer momentum periods in all frequencies which we attribute to the lower derivability of their intrinsic value leading to a higher degree of noise traders in the market. A momentum trading strategy based on the identical approach outperforms a buy-hold strategy for both asset classes, while only cryptocurrencies have higher risk-adjusted returns and lower downside risks than a passive investment. We also find critical price levels during structural elements of the momentum period where the volatility shortly but intensively increases and consequently initiates a price impulse in the direction of the momentum.     

Geopolitical risks and stock market dynamics of the BRICS

This paper examines the effect of geopolitical uncertainty on return and volatility dynamics in the BRICS stock markets via nonparametric causality-in-quantiles tests. The effect of geopolitical risks (GPRs) is found to be heterogeneous across the BRICS stock markets, suggesting that news regarding geopolitical tensions do not affect return dynamics in these markets in a uniform way. GPRs are generally found to impact stock market volatility measures rather than returns, and often at return quantiles below the median, indicating the role of GPRs as a driver of bad volatility in these markets. While Russia bears the greatest risk exposure to GPRs in terms of both return and volatility, India is found to be the most resilient BRICS nation in the group. Noting that geopolitical shocks and in particular terrorist incidents are largely unanticipated, our findings underscore the importance of a strong financial sector that can help return the market to stability and an open economy that allows local investors to diversify country-specific risks in their portfolios.     

Uncertainty across volatility regimes

We propose a nonrecursive identification scheme for uncertainty shocks that exploits breaks in the volatility of macroeconomic variables and is novel in the literature on uncertainty. This approach allows us to simultaneously address two major questions in the empirical literature: Is uncertainty a cause or effect of decline in economic activity? Does the relationship between uncertainty and economic activity change across macroeconomic regimes? Results based on a small‐scale vector autoregression with US monthly data suggest that (i) uncertainty is an exogenous source of decline of economic activity, and (ii) the effects of uncertainty shocks amplify in periods of economic and financial turmoil.     

Spillover effects on government bond yields in euro zone. Does full financial integration exist in European government bond markets?

This paper examines the time varying nature of European government bond market integration by employing multivariate GARCH models. We state that unlike other bond markets, in euro markets the default(credit) risk factor and other macroeconomic and fiscal indicators are not able to explain the sovereign bond yields after the beginning of monetary union. This fact might be counted as a signal for perfect financial integration. However, we also find that the global shocks affect Germany and the rest of euro bond markets in various levels, creating particular discrepancies in asset prices even we take into account the market specific factors. Different level responses of each euro market to the global shocks reveal that euro bond markets are not fully integrated with each other unlike the recent literature claimed. Besides, we explore that the global factors are effective for the volatility of yield differentials among euro government bonds.