An empirical analysis of the economic impact of federal terrorism reinsurance

This paper examines the role of the federal government in the market for terrorism reinsurance. We investigate the stock price response of affected industries to a sequence of 13 events culminating in the enactment of the Terrorism Risk Insurance Act (TRIA) of 2002. In the industries most likely to be affected by TRIA—banking, construction, insurance, real estate investment trusts, transportation, and public utilities-the stock price effect was primarily negative. The Act was at best value-neutral for property-casualty insurers because it eliminated the option not to offer terrorism insurance. The negative response of the other industries may be attributable to the Act's impeding more efficient private market solutions, failing to address nuclear, chemical, and biological hazards, and reducing market expectations of federal assistance following future terrorist attacks.     

An empirical analysis of herd behavior in global stock markets

This paper examines herding behavior in global markets. By applying daily data for 18 countries from May 25, 1988, through April 24, 2009, we find evidence of herding in advanced stock markets (except the US) and in Asian markets. No evidence of herding is found in Latin American markets. Evidence suggests that stock return dispersions in the US play a significant role in explaining the non-US market’s herding activity. With the exceptions of the US and Latin American markets, herding is present in both up and down markets, although herding asymmetry is more profound in Asian markets during rising markets. Evidence suggests that crisis triggers herding activity in the crisis country of origin and then produces a contagion effect, which spreads the crisis to neighboring countries. During crisis periods, we find supportive evidence for herding formation in the US and Latin American markets.     

The Samuelson hypothesis in futures markets: An analysis using intraday data

This paper considers the Samuelson hypothesis, which argues that the futures price volatility increases as the futures contract approaches its expiration. Utilizing intraday data from 20 futures markets in six futures exchanges, we find strong support for the Samuelson hypothesis in agricultural futures. However, the Samuelson hypothesis does not hold for other futures contracts. We also provide supporting evidence that the ‘negative covariance’ hypothesis is the key factor for the empirical support of the Samuelson hypothesis. In addition, our findings remain largely unaltered even after we control for seasonality and liquidity effects.     

Ripples through markets: Inter-market impacts generated by large trades

This paper uses a sample of large trades executed on the London Stock Exchange's SEAQ-I market for European cross-traded firms to investigate their impact on home market prices when parallel markets suffer from information frictions. I find that (a) large London trades produce price impacts in home markets even though no timely information is published, (b) market makers appear to pre- and post-position their inventories by splitting orders across markets, and (c) the price discovery process across markets changes significantly around large trades with the foreign market making a significantly bigger contribution to price discovery at this time, even though information opaqueness exists.     

The 2008 short sale ban: Liquidity, dispersion of opinion, and the cross-section of returns of US financial stocks

This study examines the cross-sectional impact of the 2008 short sale ban on the returns of US financial stocks. Motivated by the large cross-sectional variation in the extent to which banned stocks suffer an illiquidity shock, we hypothesize that stocks with larger liquidity declines are associated with poorer contemporaneous stock returns. The evidence supports this hypothesis and suggests that this effect is stronger for more liquid stocks, as predicted by Amihud and Mendelson (1986). Moreover, consistent with Miller’s (1977) model, we report a valuation reversal whereby stocks with higher abnormal returns at the onset of the ban have lower abnormal returns at its removal. Our findings are robust when we control for firms most affected by TARP, include non-banned matched firms, and compare banned firms’ stock returns with their bond returns. From a policy standpoint, the ban reduced valuations, ceteris paribus, of the stocks that were hardest hit by illiquidity.     

The impacts of standard monetary and budgetary policies on liquidity and financial markets: International evidence from the credit freeze crisis

This paper evaluates the domestic and international impacts of lowering short-term interest rates and increasing budget spending on several indicators of liquidity, volatility, credit and economic activity. Data from the 2003–2011 period in the United States, the Euro zone and Canada were used to develop two SVAR models for assessing the national effectiveness and the international spillovers of monetary and budgetary policies during the credit freeze crisis. While monetary policies caused a temporary decrease in volatility and increase in liquidity in North American stock markets, the shocks were mainly domestic and ineffective at generating liquidity in the banking sector. In contrast, government spending shocks had a positive impact on credit and consumption, especially in Europe and Canada. Moreover, budgetary policies also had a positive international spillover effect on consumption and credit, especially for smaller economies such as Canada.     

International day-of-the-week effects: An empirical examination of iShares

Ample evidence suggests that day-of-the-week patterns exist in US and foreign equity returns. We extend the evidence on the day-of-the-week effect in equity returns by examining the return patterns of iShares for 17 countries and Standard and Poor's Depository Receipts (SPDRs) to establish whether previously observed predictabilities in equity returns are reflected in iShares' returns. We utilize a split sample to examine return patterns and develop trading rules using the initial subsample. We then test those trading rules out of sample. Empirical results reveal that iShares exhibit day-of-the-week return patterns that can be exploited by informed traders.     

Simultaneous monetary policy announcements and international stock markets response: An intraday analysis

This paper investigates the return and volatility response of major European and US equity indices to monetary policy surprises by utilizing extensive intraday data on 5-min price quotes along with a comprehensive dataset on monetary policy decisions and macroeconomic news announcements. The results indicate that the monetary policy decisions generally exert immediate and significant influence on stock index returns and volatilities in both European and the US markets. The findings also show that press conferences held by the European Central Bank (ECB) that follow monetary policy decisions on the same day have a clear impact on European index return volatilities. This implies that they convey additional important information to market participants. Overall, our analysis suggests that the use of high frequency data is critical to separate the effect of monetary policy actions from those of macroeconomic news announcements on stock index returns and volatilities.     

An empirical study of portfolio-balance and information effects of order flow on exchange rates

We propose a simple structural model of exchange rate determination which is inspired by the analytical framework recently forward by Bacchetta and van Wincoop (2006) and allows us to disentangle the portfolio-balance and information effects of order flow on exchange rates. We estimate this model employing an innovative transaction data-set that covers all indirect foreign exchange transactions completed in the USD/EUR market via EBS and Reuters between August 2000 and January 2001. Our results indicate that the strong contemporaneous correlation between order flow and exchange rates is largely due to portfolio-balance effects. This result also appears to carry through the four FX intervention events that appear in our sample.     

The impact of central clearing on counterparty risk,liquidity, and trading: Evidence from the credit default swap market

This paper examines the impact of central clearing on the credit default swap (CDS) market using a sample of voluntarily cleared single-name contracts. Consistent with central clearing reducing counterparty risk, CDS spreads increase around the commencement of central clearing and are lower than settlement spreads published by the central clearinghouse. Furthermore, the relation between CDS spreads and dealer credit risk weakens after central clearing begins, suggesting a lowering of systemic risk. These findings are robust to controls for frictions in both CDS and bond markets. Finally, matched sample analysis reveals that the increased post-trade transparency following central clearing is associated with an improvement in liquidity and trading activity.     

The wandering weekday effect in major stock markets

This paper reports a wandering weekday effect: the pattern of day seasonality in stock market returns is not fixed, as assumed in the Monday or weekend effects, but changes over time. Analysing daily closing prices in eleven major stock markets during 1993–2007, our results show that the wandering weekday is not conditional on average returns in the previous week (the “twist” in the Monday effect). Nor does it diminish through the period of analysis. The results have important implications for market efficiency, and help to reconcile mixed findings in previous studies, including the reported disappearance of the weekday effect in recent years.     

The asset growth effect: Insights from international equity markets

Firms with higher asset growth rates subsequently experience lower stock returns in international equity markets, consistent with the U.S. evidence. This negative effect of asset growth on returns is stronger in more developed capital markets and markets where stocks are more efficiently priced, but is unrelated to country characteristics representing limits to arbitrage, investor protection, and accounting quality. The evidence suggests that the cross-sectional relation between asset growth and stock return is more likely due to an optimal investment effect than due to overinvestment, market timing, or other forms of mispricing.     

Market liquidity in the financial crisis: The role of liquidity commonality and flight-to-quality

We examine the dynamics and the drivers of market liquidity during the financial crisis, using a unique volume-weighted spread measure. According to the literature we find that market liquidity is impaired when stock markets decline, implying a positive relation between market and liquidity risk. Moreover, this relationship is the stronger the deeper one digs into the order book. Even more interestingly, this paper sheds further light on so far puzzling features of market liquidity: liquidity commonality and flight-to-quality. We show that liquidity commonality varies over time, increases during market downturns, peaks at major crisis events and becomes weaker the deeper we look into the limit order book. Consistent with recent theoretical models that argue for a spiral effect between the financial sector’s funding liquidity and an asset’s market liquidity, we find that funding liquidity tightness induces an increase in liquidity commonality which then leads to market-wide liquidity dry-ups. Therefore our findings corroborate the view that market liquidity can be a driving force for financial contagion. Finally, we show that there is a positive relationship between credit risk and liquidity risk, i.e., there is a spread between liquidity costs of high and low credit quality stocks, and that in times of increased market uncertainty the impact of credit risk on liquidity risk intensifies. This corroborates the existence of a flight-to-quality or flight-to-liquidity phenomenon also on the stock markets.     

Market discipline and the evaluation of Euro financial bonds—An empirical analysis

Within the context of the increasing discussion on a shift in financial regulatory philosophy from the currently prevailing rules-based approach to a more incentive-based supervisory procedure in which market discipline should play a decisive role in overcoming several moral hazard and efficiency problems of the financial system, the question regarding the evaluation of financial bonds has gained an important dimension. Such a disciplining market influence could namely be exercised if financial institutions were obliged to issue subordinated bonds on a regular basis (mandatory subordinated debt policy). However, the influence of market discipline will only be effective if the evaluation of different subordinated (and other) bonds occurs in a differentiated manner and dependent on the inherent risks. This study provides findings, on the basis of which this requirement for the Euro financial bond market can be regarded as fulfilled.     

An international CAPM for partially integrated markets: Theory and empirical evidence

This article proposes a theoretical testable capital asset pricing model for partially segmented markets. We establish that if some investors do not hold all international assets because of direct and/or indirect barriers, the world market portfolio is not efficient and the traditional international CAPM must be augmented by a new factor reflecting the local risk undiversifiable internationally. We also introduce a suitable framework to test this model empirically. Using a sample of six emerging markets and three mature markets, we find that the degree of stock market integration varies through time and that most of the sample emerging markets have become more integrated in the recent years. The local risk premium for emerging markets represents the most important component of the total risk premium, but its relative importance has decreased recently. Differently, the total risk premium for developed countries is largely driven by global factors.     

Hedge funds,CDOs and the financial crisis: An empirical investigation of the “Magnetar trade”

The so called Magnetar trade (a kind of capital structure arbitrage on the US housing market, using CDS and synthetic CDOs, and exploiting rating-dependent mispricing of risk) has gained a high publicity due to a Pulitzer Prize awarded media story from two journalists of ProPublica (an online news outlet). The story essentially claimed that the mortgage investment strategy of the hedge fund Magnetar during the period between 2006 and mid 2007 was based on a desire to construct CDO deals with riskier assets so that they could place bets that portions of their own deals would fail. This paper provides several pieces of evidence in line with the argument that tranches from Magnetar-sponsored CDOs present overly risky investments. However, investors and rating agencies appear to have adjusted their required spread levels and ratings to reflect this higher riskiness, at least to some extent.     

The 52-week high momentum strategy in international stock markets

We study the 52-week high momentum strategy in international stock markets proposed by George and Hwang [George, T., Hwang, C.Y., 2004. The 52-week high and momentum investing. Journal of Finance 59, 2145-2176.]. This strategy produces profits in 18 of the 20 markets studied, and the profits are significant in 10 markets. The 52-week high momentum profits exist independently from the Jegadeesh and Titman [Jegadeesh, N., Titman, S., 1993. Returns to buying winners and selling losers: implications for market efficiency. Journal of Finance 48, 65-91.] individual stock and Moskowitz and Grinblatt [Moskowitz, T.J., Grinblatt, M., 1999. Do industries explain momentum? Journal of Finance 54, 1249-1290] industry momentum strategies. These profits do not show reversals in the long run. We find that the 52-week high is a better predictor of future returns than macroeconomic risk factors or the acquisition price. The individualism index, a proxy to the level of overconfidence, has no explanatory power to the variations of the 52-week high momentum profits across different markets. However, the profits are no longer significant in most markets once transaction costs are taken into account.     

The impact of sovereign rating actions on bank ratings in emerging markets

This paper analyses the effects of sovereign rating actions on the credit ratings of banks in emerging markets, using a sample from three global rating agencies across 54 countries for 1999–2009. Despite widespread attention to sovereign ratings and bank ratings, no previous study has investigated the link in this manner. We find that sovereign rating upgrades (downgrades) have strong effects on bank rating upgrades (downgrades). The impact of sovereign watch status on bank rating actions is much weaker and often insignificant. The sensitivity of banks’ ratings to sovereign rating actions is affected by the countries’ economic and financial freedom and by macroeconomic conditions. Ratings of banks with different ownership structures are all influenced strongly by the sovereign rating, with some variation depending on the countries’ characteristics. Emerging market bank ratings are less likely to follow sovereign rating downgrades during the recent financial crisis period.     

Empirical relationship between macroeconomic volatility and stock returns: Evidence from Latin American markets

Emerging market stock returns have been characterized as having higher volatility than returns in the more developed markets. But previous studies give little attention to the fundamentals driving the reported levels of volatility. This paper investigates whether dynamics in key macroeconomic indicators like exchange rates, interest rates, industrial production and money supply in four Latin American countries significantly explain market returns. The MSCI world index and the U.S. 3-month T-bill yield are also included to proxy the effects of global variables. Using a six-variable vector autoregressive (VAR) model, the study finds that the global factors are consistently significant in explaining returns in all the markets. The country variables are found to impact the markets at varying significance and magnitudes. These findings may have important implications for decision-making by investors and national policymakers.     

Equity market integration in emerging Balkan markets

This paper examines long-run relationships among five Balkan emerging stock markets (Turkey, Romania, Bulgaria, Croatia, Serbia), the United States and three developed European markets (UK, Germany, Greece), during the period 2000-2009. Conventional, regime-switching cointegration tests and Monte Carlo simulation provide evidence in favour of a long-run cointegrating relationship between the Balkan emerging markets within the region and globally. Moreover, we apply the Asymmetric Generalized Dynamic Conditional Correlation (AG-DCC) multivariate GARCH model of Cappiello et al. (2006), in order to capture the impact of the 2007-2009 financial crisis on the time-varying correlation dynamics among the developed and the Balkan stock markets. Results show that stock market dependence is heightened, supporting the herding behaviour during the 2008 stock market crash period. Our findings have important implications for international portfolio diversification and the effectiveness of domestic policies, as these emerging markets are exposed to external shocks.