Common asset pricing factors in volatilities and returns in futures markets

Factor-based asset pricing models have been used to explain the common predictable variation in excess asset returns. This paper combines means with volatilities of returns in several futures markets to explain their common predictable variation. Using a latent variables methodology, tests do not reject a single factor model with a common time-varying factor loading. The single common factor accounts for up to 53% of the predictable variation in the volatilities and up to 14% of the predictable variation in the means. S&P500 futures volatility predicted by the factor model is highly correlated with volatility implied in S&P500 futures options. But both the factor and implied volatilities are significant in predicting future volatility. In derivatives pricing, both implied volatility from options and factors extracted from asset pricing models should be employed.     

CAPM option pricing

This paper extends the option pricing equations of [Black and Scholes, 1973] , [Jarrow and Madan, 1997] and [Husmann and Stephan, 2007] . In particular, we show that the length of the individual planning horizon is a determinant of an option’s value. The derived pricing equations can be presented in terms of the Black and Scholes [1973. Journal of Political Economy 81, 637–654] option values which ensures an easy application in practice.     

Nonparametric estimation and testing of stochastic discount factor

This paper attempts to estimate stochastic discount factor (SDF) proxies nonparametrically using the conditional Hansen–Jagannathan distance. Nonparametric estimation can not only avoid misspecification when dealing with nonlinearity in the model but also provide more precise information about the local properties of the estimators. Empirical studies show that our method performs better than the alternative parametric polynomial models, and furthermore, we find that the return on aggregate wealth can sufficiently explain the SDF proxies when one deals with nonlinearity appropriately.     

The persistence of bank profit

This paper examines the intensity of competition in 65 national banking industries. Country-level dynamic panel estimates of the persistence of bank profit are reported and compared. Persistence of bank profit is interpreted as an indicator of the intensity of competition, and as such is found to be consistent with traditional structure-based and conduct-based competition indicators. Persistence is negatively related to the rate of growth in GDP per capita, and positively related to the size of entry barriers. Persistence tends to be weaker, and competition stronger, in countries where institutional development is more advanced and external governance mechanisms are strong.     

Financial asset demand is elastic: Evidence from new issues of Federal Home Loan Bank debt

We estimate the slope of the demand curve for newly auctioned FHLB discount notes and investigate the impacts of arbitrage risk and heterogeneity of investor beliefs on demand elasticity. Our unique dataset of roughly 2900 observations of two price-quantity pairs—the first from a pre-auction dealer survey, the second from actual auction results—provides the quantity shift necessary to identify demand. In contrast to previous findings of downward-sloping demand curves for equities, we show that demand for newly issued FHLB notes is nearly perfectly elastic during normal market conditions. We find, however, that frictions like arbitrage risk and, to a lesser extent, heterogeneity of investor beliefs negatively affect elasticity and explain the nearly 50% drop in elasticity observed during the recent financial crisis.     

Banking 3.0—Designing financial regulation systems: The case for simple rules

In the past quarter century, financial innovation and deregulation have increasingly pushed the banks into shadow banking, magnifying the risks and leaving the regulators bereft of the tools needed to analyze and manage an increasingly complex and interconnected system. The purpose of the new regulatory process should be to return banks their intermediation function. However, the system has to focus on simplicity, and its purpose has to be to promote effective risk management, transparency and accountability by changing incentives without burdening the banking system with crippling capital and regulatory requirements.     

Do Japanese banks lead or follow international business? An empirical investigation

Although many precedent studies analyze the factors that promote the internationalization of banks, we have no empirical evidence answering the question as to whether banks follow or lead the manufacturing industries. In this paper, we investigate empirically whether Japanese banks are leaders or followers of the manufacturing industries in the process of internationalization. Using the Granger causality test based on Hsiao's (Hsiao, 1979, 1981) sequential test procedures, we find that Japanese banks have led Japanese manufacturing industries in the process of internationalization in Asia and Oceania and that banks have followed the manufacturing industries in the Near East. Furthermore, there is no clear causality in North America and Europe. The banks' leadership in Asia and Oceania seems to demonstrate that Japanese banks have comparative advantage against host-country competitors in these regions, while Japanese banks seem to enter US or European financial centers in order to avoid domestic regulations.     

Habit-based asset pricing with limited participation consumption

We calibrate and estimate a consumption-based asset pricing model with habit formation using limited participation consumption data. Based on survey data of a representative sample of American households, we distinguish between assetholder and non-assetholder consumption, as well as the standard aggregate consumption series commonly used in the CCAPM literature. We show that assetholder consumption outperforms non-assetholder and aggregate consumption data in explaining bond returns, bond yields, and the volatility of bond yields. We further show that the high volatility of assetholder consumption enables the model to explain the equity premium puzzle and the risk-free rate puzzle simultaneously for a reasonable value of relative risk aversion.     

The effects of loan portfolio concentration on Brazilian banks’ return and risk

This paper tests whether diversification of the credit portfolio at the bank level leads to better performance and lower risk. We employ a new high frequency (monthly) panel data for the Brazilian banking system with information at the bank level for loans by economic sector. We find that loan portfolio concentration increases returns and also reduces default risk; the impact of concentration on bank’s return is decreasing on bank’s risk; there are significant size effects; foreign and state-owned banks seem to be less affected by the degree of diversification. An important additional finding is that there is an increasing concentration trend after the breakout of the recent international financial crisis, specially after the failure of Lehman Brothers.     

Deposit insurance and subsidized recapitalizations

The 2007–2009 financial crisis saw a vast expansion in deposit insurance guarantees around the world and yet our understanding of the design and consequences of deposit insurance schemes is in its infancy. We provide a new rationale for the provision of deposit insurance. In our model the banking sector exhibits both adverse selection and moral hazard, which implies that the social benefits of bank monitoring must for incentive reasons be shared between depositors and banks. Consequently, socially too few deposits are made in equilibrium. Deposit insurance – or, equivalently, bank recapitalization – corrects this market failure. We find that deposit insurance should be funded not by banks or depositors but out of general taxation. The optimal level of deposit insurance varies inversely with the quality of the banking system. Hence, when the soundness of the financial sector is uncertain, governments should consider supporting deposit insurance schemes and undertaking subsidized recapitalizations.     

The price of gold and the exchange rate

This paper examines the theoretical relationship between the major exchange rates and the prices of internationally-traded commodities. In the empirical section, the case of gold is analyzed using forecast error data. Among other things, it is found that, since the dissolution of the Bretton Woods International monetary system, floating exchange rates among the major currencies have been a major source of price instability in the world gold market and, as the world gold market is dominated by the European currency bloc, appreciations or depreciations of European currencies have strong effects on the price of gold in other currencies.     

The effect of monetary policy on real estate price growth in China

Using quarterly data from 1998:Q1 to 2009:Q4 and monthly data from July 2005 to February 2010, this paper examines the impact of key monetary policy variables, including long-term benchmark bank loan rate, money supply growth, and mortgage credit policy indicator, on the real estate price growth dynamics in China. Empirical results consistently demonstrate that expansionary monetary policy tends to accelerate the subsequent home price growth, while restrictive monetary policy tends to decelerate the subsequent home price growth. These results suggest that Chinese monetary policy actions are the key driving forces behind the change of real estate price growth in China. We also show that hot money flow does not have a significant impact on the change of home price growth after controlling for the money supply growth. Finally, a bullish stock market tends to accelerate subsequent home price growth.     

The incremental volatility information in one million foreign exchange quotations

The volatility information found in high-frequency exchange rate quotations and in implied volatilities is compared by estimating ARCH models for DM/$ returns. Reuters quotations are used to calculate five-minute returns and hence hourly and daily estimates of realised volatility that can be included in equations for the conditional variances of hourly and daily returns. The ARCH results show that there is a significant amount of information in five-minute returns that is incremental to options information when estimating hourly variances. The same conclusion is obtained by an out-of-sample comparison of forecasts of hourly realised volatility.     

Trading frequency and asset pricing on the London Stock Exchange: Evidence from a new price impact ratio

This study proposes a new price impact ratio as an alternative to the widely used Amihud’s (2002) Return-to-Volume ratio. We demonstrate that the new price impact ratio, which is deemed Return-to-Turnover ratio, has a number of appealing features. Using daily data from all stocks listed on the London Stock Exchange over the period 1991–2008, we provide overwhelming evidence that this ratio, while being unequivocal to construct and interpret, is also free of a size bias. More importantly, it encapsulates the stocks’ cross-sectional variability in trading frequency, a relatively neglected but possibly important determinant of stock returns given the recently observed trends in financial markets. Overall, our findings argue against the conventional wisdom that there is a simple direct link between trading costs and stock returns by strongly suggesting that it is the compound effect of trading frequency and transaction costs that matters for asset pricing, not each aspect in isolation.     

Are small family firms financially sophisticated?

We study the drivers of financial sophistication in small family firms. Sophistication is defined as the use of non-basic financial products such as options, swaps, debt restructuring, and mergers and acquisitions (M&A) advisory services. Our analysis is based on a unique dataset with detailed information on 187 Italian family firms. We find that the main drivers of financial sophistication are: (1) the generation that currently owns the firm; (2) the presence of a non-family CFO; and (3) the existence of a non-family shareholder. We analyze the impact of these factors on the following four classes of non-basic financial products: corporate finance, cash management, corporate lending and risk management. Our results can be used to determine the characteristics of financially sophisticated family firms and whether their corporate governance and ownership structure increase the use of non-basic financial products.     

Investor type trading behavior and trade performance: Evidence from the Thai stock market

This paper examines the trading behavior and decomposes the trading performance of foreign, individual and institutional investors as well as proprietary traders in a dynamic emerging stock market, the Stock Exchange of Thailand. Foreign investors follow a positive feedback, momentum strategy and are good short term market timers but have poor security selection performance in poor markets, thus suggesting that they have a macro (market timing) but not a micro (security selection) informational advantage relative to local investors. Institutions and proprietary traders have poor security selection trading performance. Individuals display herding behavior and have fairly good security selection performance, but individual investors appear to compensate proprietary traders for the provision of short term liquidity by proprietary traders, so individuals' security selection gains are canceled out by market timing losses.     

Basel Core Principles and bank soundness: Does compliance matter?

This paper studies whether compliance with the Basel Core Principles for effective banking supervision (BCPs) is associated with bank soundness. Using data for over 3000 banks in 86 countries, we find that neither the overall index of BCP compliance nor its individual components are robustly associated with bank risk measured by individual bank Z-scores. We also fail to find a relationship between BCP compliance and systemic risk measured by a system-wide Z-score.     

The impacts of large trades by trader types on intraday futures prices: Evidence from the Taiwan Futures Exchange

We find that China's P/E ratio is comparable to that of the U.S. S&P 1500 index, a broad based index covering large, middle, and small capitalization firms. We provide an explanation as to why China's seemingly low P/E ratio is not surprising in light of the economic growth that it has experienced. Specifically, we show that (i) the P/E ratio is negatively associated with earnings volatility in both the Chinese and U.S. stock markets with an economically significant magnitude; and (ii) historical earnings volatility is considerably higher in China than in the U.S. Higher earnings volatility in China offsets higher growth prospect in setting the P/E ratio, making its P/E ratio much closer to what is observed empirically than otherwise implied by its growth rate.