Classification of intraday S&P500 returns with a Random Forest

Stock markets can be interpreted to a certain extent as prediction markets, since they can incorporate and represent the different opinions of investors who disagree on the implications of the available information on past and expected events and trade on their beliefs in order to achieve profits. Many forecast models have been developed for predicting the future state of stock markets, with the aim of using this knowledge in a trading strategy. This paper interprets the classification of the S&P500 open-to-close returns as a four-class problem. We compare four trading strategies based on a random forest classifier to a buy-and-hold strategy. The results show that predicting the classes with higher absolute returns, ‘strong positive’ and ‘strong negative’, contributed the most to the trading strategies on average. This finding can help shed light on the way in which using additional event outcomes for the classification beyond a simple upward or downward movement can potentially improve a trading strategy.     

Failure to learn from failure: The 2008 mortgage crisis as a déjà vu of the mortgage meltdown of 1994

This article traces the developments in the market for residential mortgage-backed securities (MBS) during the period 1970–2008. Drawing on an analysis of trade publications, business press, and interviews with practitioners, it shows that an MBS market meltdown in 1994 provided clear signals of problems with MBS. The market participants did not re-evaluate their use of risk management tools or adjust security design in response to the 1994 crisis, suggesting a lack of understanding of the implications of the crisis. The 1994 meltdown showed that MBS were vulnerable to systematic risks and that these risks could precipitate an MBS market crash. Furthermore, the 1994 meltdown demonstrated that large-scale investment in MBS could affect the primary mortgage market, thereby rendering the MBS risks unpredictable. After 1994, MBS investment shifted to MBS backed by mortgages with default risk – a development that led to the crash of 2008. By drawing parallels between the 1994 and 2008 crises, this article shows how the MBS market failed to self-correct. The results suggest that financial market participants do not always incorporate relevant information in their decision-making and that market participants have difficulties in both foreseeing the effect of financial innovations on markets and interpreting these effects.     

Joint tests of contagion with applications

Joint tests of contagion are derived which are designed to have power where contagion operates simultaneously through coskewness, cokurtosis and covolatility. Finite sample properties of the new tests are evaluated and compared with existing tests of contagion that focus on a single channel. Applying the tests to daily euro zone equity returns from 2005 to 2014 shows that contagion operated mainly through higher order moment channels during the GFC and the European debt crisis, which were not necessarily detected by traditional tests based on correlations. The empirical results have important implications for pricing risk and constructing well diversified portfolios.     

A multivariate distance nonlinear causality test based on partial distance correlation: a machine learning application to energy futures

This paper proposes a multivariate distance nonlinear causality test (MDNC) using the partial distance correlation in a time series framework. Partial distance correlation as an extension of the Brownian distance correlation calculates the distance correlation between random vectors X and Y controlling for a random vector Z. Our test can detect nonlinear lagged relationships between time series, and when integrated with machine learning methods it can improve the forecasting power. We apply our method as a feature selection procedure and combine it with the support vector machine and random forests algorithms to study the forecast of the main energy financial time series (oil, coal, and natural gas futures). It shows substantial improvement in forecasting the fuel energy time series in comparison to the classical Granger causality method in time series.     

金融创新如何缓解信任品市场失灵?——中国食品安全责任强制保险的自然实验

信任品市场(如食品、医药等)存在的问题一直困扰着中国和世界很多国家。关于产品和服务质量的信息不对称(道德风险和逆向选择)会导致信任品市场失灵。缓解信任品市场失灵,一种常见的解决方案是政府监管;而经济学家认为更加基于市场的解决方案(例如强制责任保险等金融创新)可能更为有效。在理论上,强制责任保险有两种相反的效应:保险公司的监督减少了道德风险 vs. 保险加剧了企业的道德风险,但一直亟待实证检验。幸运的是,中国食品安全责任强制保险的改革实验走在了世界的前列。本文利用了中国在不同地区、不同时间推行的这个自然实验,通过双重差分的方法识别出责任保险对于信任品市场的因果效应。本文的研究发现,强制责任保险能显著降低食品安全事故发生概率。这表明政府强制推行的金融创新可以成为信任品市场失灵的一种有效的替代性解决方案。     

Switching costs and financial stability

We establish that the effect of intensified deposit market competition, measured by reduced switching costs, on the probability of bank failures depends critically on whether we focus on competition with established customer relationships or competition for the formation of such relationships. With inherited customer relationships, intensified competition due to lower switching costs destabilizes the banking market, whereas it stabilizes the market if we focus on competition for the formation of customer relationships. We characterize the factors important for evaluating the effects of intensified competition on stability in a market with unattached as well as locked-in depositors.     

Predatory cells and puzzling financial crises: Are toxic products good for the financial markets?

We advance the idea that the predator-prey dynamics that take place among key market agents play an important role in explaining financial crises. As such, we posit that financial markets evolve through fault lines involving toxic behaviors (such as deceit), toxic products (such as predatory mortgages) and inefficient regulations. We provide data to show that the puzzle of the lack of congruence between the market behaviors and what some economic models predict at times of financial crises may be the result of predator-prey interplays, and of so-called “predatory cells”, which are under the influence of financial accelerators.     

Strategic consequences of being unsympathetic: For‐profit companies benefit more than individuals from focusing on responsibility

Previous research has found that consumers ascribe mental states to for‐profit companies that enable them to elicit anger more easily than sympathy. The current study applies these findings to demonstrate how this evaluative asymmetry in consumer perceptions favor different strategies for individuals and companies managing conflicts and crises. First, it is shown that the mental states consumers ascribe to for‐profit companies enable them to elicit anger and admiration more easily than sympathy. Second, due to their ability to elicit anger more easily than sympathy, it is found that in conflicts between for‐profit companies and individuals, companies are evaluated more favorably when they focus attention on which side perpetrated the most harm, while individuals are evaluated more favorably when they focus on which side was most victimized. Third, due to their ability to elicit admiration more easily than sympathy, it is found that for‐profit companies derive greater benefits than individuals do from proactively taking responsibility to resolve crises rather than deflecting responsibility through claims of victimhood. Discussion focuses on marketing applications for companies managing conflicts and crises.     

Relying on the heuristic of trust: a case study

This study examines the reliance on trust as a heuristic by individuals when making personal financial decisions, using a qualitative case study. We show that in the face of complexity and choice, individual investors predominantly resorted to the heuristic of trust to make financial decisions. This demonstrates the need for industry and public policy‐makers to be aware that individuals can and will resort to simplified heuristics as a basis for financial decision‐making, particularly within an environment where substantial complexity and choice exist.     

Foreign Investment in Emerging Markets: International Diversification or Familiarity Bias?

This study empirically tests whether foreign investors take advantage of international diversification when investing in emerging Asian markets. Using the 2007–2008 financial crisis as identification, we find that firms with higher foreign ownership had better stock returns during the financial crisis. Moreover, the diversification effect exists in five out of the eight emerging markets and is stronger in markets with a lower dynamic conditional correlation with the global market index. We also find that foreign investors prefer firms with a lower international sales ratio. In conclusion, the evidence consistently suggests that foreign investors take advantage of diversification effects.