An analysis of trading strategies in eleven European stock markets

Abstract

In recent years, the validity of the weak form efficient market hypothesis (EMH) has been called into question as several studies have uncovered evidence that technical trading rules have predictive ability with respect to both developed and emerging stock market indices. This study analyses the forecasting power of 2 of the most popular trading rules using index data for a selection of 11 European stock markets over the January 1991 to December 2000 period. The findings indicate that the emerging markets included in this paper are informationally inefficient; these markets displayed some degree of predictability in their share returns, although the developed markets did not. Furthermore, the results point to large differences in the performance of the rules examined; while small size filters consistently outperformed the buy-and-hold strategy in the emerging markets examined even after the consideration of transaction costs, the performance of the moving average rules was erratic and varied dramatically from market to market.     

The changing and relative efficiency of European emerging stock markets

The martingale hypothesis is tested for 15 European emerging stock markets located in Croatia, the Czech Republic, Estonia, Hungary, Iceland, Latvia, Lithuania, Malta, Poland, Romania, Russia, the Slovak Republic, Slovenia, Turkey and the Ukraine. For comparative purposes, the developed stock markets in Greece, Portugal and the UK are also included. Rolling window variance ratio tests based on returns and signs and with wild bootstrapped p-values are used with daily data over the period beginning in February 2000 and ending in December 2009. The fixed-length rolling sub-period window captures changes in efficiency and is used to identify events which coincide with departures from weak-form efficiency and to rank markets by relative efficiency. Overall, return predictability varies widely. The most efficient are the Turkish, UK, Hungarian and Polish markets; the least efficient are the Ukrainian, Maltese and Estonian stock markets. The global financial market crisis of 2007–2008 coincides with return predictability in the Croatian, Hungarian, Polish, Portuguese, Slovakian and UK stock markets. However, not all markets were affected: the crisis had little effect on weak-form efficiency in stock markets located in Greece, Latvia, Romania, Russia and Turkey.     

Executive compensation in less regulated markets: the impact of debt monitoring

This paper shows that in the lightly regulated Alternative Investment Market (AIM) voluntary corporate board structures might not reduce agency costs between shareholder and executive directors. In this less regulated market, we find that the extent of debt affects executive pay. In addition, the theoretical determinants of executive pay affect CEO and other executives’ pay and incentives differently in this market. We find no evidence that debt levels affect CEO pay in a matched sample of Main Market firms. Our results suggest that debtholders could be better monitors of executive directors’ actions, in comparison to voluntary governance committees in less regulated markets.     

There's more to volatility than volume

It is widely believed that fluctuations in transaction volume, as reflected in the number of transactions and to a lesser extent their size, are the main cause of clustered volatility. Under this view bursts of rapid or slow price diffusion reflect bursts of frequent or less frequent trading, which cause both clustered volatility and heavy tails in price returns. We investigate this hypothesis using tick by tick data from the New York and London Stock Exchanges and show that only a small fraction of volatility fluctuations are explained in this manner. Clustered volatility is still very strong even if price changes are recorded on intervals in which the total transaction volume or number of transactions is held constant. In addition the distribution of price returns conditioned on volume or transaction frequency being held constant is similar to that in real time, making it clear that neither of these are the principal cause of heavy tails in price returns. We analyse recent results of Ane and Geman (2000 Ane, T and Geman, H. 2000. Order flow, transaction clock, and normality of asset returns. J. Finance, 55(5): 2259–2284. [Crossref], [Web of Science ®] , [Google Scholar]: J. Finance, 55, 2259–2284) and Gabaix et al. (2003 Gabaix, X, Gopikrishnan, P, Plerou, V and Stanley, H.E. 2003. A theory of power-law distributions in financial market fluctuations. Nature, 423: 267–270. [Crossref], [PubMed], [Web of Science ®] , [Google Scholar]: Nature, 423, 267–270), and discuss the reasons why their conclusions differ from ours. Based on a cross-sectional analysis we show that the long-memory of volatility is dominated by factors other than transaction frequency or total trading volume.     

The next tick on Nasdaq

The Nasdaq stock market provides information about buying and selling interest in its limit order book. Using a vector autoregressive model of trades and returns, I assess the effect of the entire order book on the next tick. I also determine the influence of individual market makers and electronic networks and find evidence that the identity of market participants can be useful information. Finally, I produce a set of dynamic market price responses to buy and sell orders, and I find that these estimates vary with standard measures of liquidity.     

Estimating default barriers from market information

Brockman and Turtle [J. Finan. Econ., 2003, 67, 511–529] develop a barrier option framework to show that default barriers are significantly positive. Most implied barriers are typically larger than the book value of corporate liabilities. We show theoretically and empirically that this result is biased due to the approximation of the market value of corporate assets by the sum of the market value of equity and the book value of liabilities. This approximation leads to a significant overestimation of the default barrier. To eliminate this bias, we propose a maximum likelihood (ML) estimation approach to estimate the asset values, asset volatilities, and default barriers. The proposed framework is applied to empirically examine the default barriers of a large sample of industrial firms. This paper documents that default barriers are positive, but not very significant. In our sample, most of the estimated barriers are lower than the book values of corporate liabilities. In addition to the problem with the default barriers, we find significant biases on the estimation of the asset value and the asset volatility of Brockman and Turtle.     

Predictability of nonlinear trading rules in the U.S. stock market

Most of the existing technical trading rules are linear in nature. This paper investigates the predictability of nonlinear time series model based trading strategies in the U.S. stock market. The performance of the nonlinear trading rule is compared with that of the linear model based rules. It is found that the self-exciting threshold autoregressive (SETAR) model based trading rules perform slightly better than the AR rules for the Dow Jones and Standard and Poor 500, while the AR rules perform slightly better in the NASDAQ market. Both the SETAR and the AR rules outperform the VMA rules. The results are confirmed by bootstrap simulations.     

The impact of transaction duration,volume and direction on price dynamics and volatility

We explore the role of trade volume, trade direction, and the duration between trades in explaining price dynamics and volatility using an Asymmetric Autoregressive Conditional Duration model applied to intraday transactions data. Our results suggest that volume, direction and duration are important determinants of price dynamics, while duration is also an important determinant of volatility. However, the impact of volume and direction on volatility is marginal after controlling for duration, and the impact of volume on volatility appears to be confined to periods of infrequent trading.     

Modeling default risk with support vector machines

Predicting default risk is important for firms and banks to operate successfully. There are many reasons to use nonlinear techniques for predicting bankruptcy from financial ratios. Here we propose the so-called Support Vector Machine (SVM) to predict the default risk of German firms. Our analysis is based on the Creditreform database. In all tests performed in this paper the nonlinear model classified by SVM exceeds the benchmark logit model, based on the same predictors, in terms of the performance metric, AR. The empirical evidence is in favor of the SVM for classification, especially in the linear non-separable case. The sensitivity investigation and a corresponding visualization tool reveal that the classifying ability of SVM appears to be superior over a wide range of SVM parameters. In terms of the empirical results obtained by SVM, the eight most important predictors related to bankruptcy for these German firms belong to the ratios of activity, profitability, liquidity, leverage and the percentage of incremental inventories. Some of the financial ratios selected by the SVM model are new because they have a strong nonlinear dependence on the default risk but a weak linear dependence that therefore cannot be captured by the usual linear models such as the DA and logit models.     

Monitoring the board: should shareholders have direct proxy access?

Motivated by the current discussion to reform shareholder-nominated director elections, this paper presents a model that shows that, when shareholders have direct access to proxy, the quality of the board of directors improves. This is so because more independent directors—regarded as better monitors of managerial activities—will be elected. In the model, a manager maximizes his expected utility by solving the trade-off between reputation and consumption of private benefits. The board can be of high-type (independent, only cares about reputation) or low-type (non-independent, faces a trade-off similar to the manager's). When the board can signal its type at a relatively small cost, giving shareholders direct access to proxy is better than delegating the nomination of outside directors to managers: in the first alternative, only high-type boards will be kept, whereas in the second, low-type boards will predominate.