Are stock markets really so inefficient? The case of the “Halloween Indicator”

The old and simple investment strategy “Sell in May and Go Away” (also referred to as the “Halloween effect”) enjoys an unbroken popularity. Recent studies suggest that the Halloween effect even strengthened rather than weakened since its first publication by Bouman and Jacobsen (2002). We implement regression models as well as Hansen’s (2005) “Superior Predictive Ability” test to analyze whether stock markets are really so inefficient. In line with the predictions of market efficiency, our results reject the hypothesis that a trading strategy based on the Halloween effect significantly outperforms.     

Momentum and Foreign Investors: Evidence from the Korean Stock Market

Abstract:

We examine whether the price impact of foreign investors on the Korean stock market from December 2000 to February 2007 generated a momentum phenomenon. In our empirical results, foreigners seem to have exerted a significantly positive impact on prices in “up” markets (periods of positive stock returns), but have had little impact on prices in “down” markets (periods of negative returns). We document that the impact of foreigners’ trades is concentrated in large companies. Most importantly, when the market is in the up state, the returns of stocks of large companies that were positively affected by foreign investors in the previous six-month period continue to increase in the subsequent six-month period. As a result, the subsequent six-month return on a past “winner” stock portfolio is significantly higher than that on a past “loser” stock portfolio. This brings to mind a momentum phenomenon that has been reported not to exist in the Korean stock market.     

Extreme observations and risk assessment in the equity markets of MENA region: Tail measures and Value-at-Risk

The standard “delta-normal” Value-at-Risk methodology requires that the underlying returns generating distribution for the security in question is normally distributed, with moments which can be estimated using historical data and are time-invariant. However, the stylized fact that returns are fat-tailed is likely to lead to under-prediction of both the size of extreme market movements and the frequency with which they occur. In this paper, we use the extreme value theory to analyze four emerging markets belonging to the MENA region (Egypt, Jordan, Morocco, and Turkey). We focus on the tails of the unconditional distribution of returns in each market and provide estimates of their tail index behavior. In the process, we find that the returns have significantly fatter tails than the normal distribution and therefore introduce the extreme value theory. We then estimate the maximum daily loss by computing the Value-at-Risk (VaR) in each market. Consistent with the results from other developing countries [see Gencay, R. and Selcuk, F., (2004). Extreme value theory and Value-at-Risk: relative performance in emerging markets. International Journal of Forecasting, 20, 287–303; Mendes, B., (2000). Computing robust risk measures in emerging equity markets using extreme value theory. Emerging Markets Quarterly, 4, 25–41; Silva, A. and Mendes, B., (2003). Value-at-Risk and extreme returns in Asian stock markets. International Journal of Business, 8, 17–40], generally, we find that the VaR estimates based on the tail index are higher than those based on a normal distribution for all markets, and therefore a proper risk assessment should not neglect the tail behavior in these markets, since that may lead to an improper evaluation of market risk. Our results should be useful to investors, bankers, and fund managers, whose success depends on the ability to forecast stock price movements in these markets and therefore build their portfolios based on these forecasts.     

The Cross-Section of Stock Returns on The Shanghai Stock Exchange

This study explores the cross-sectional stock return behavior on the A-share market of the Shanghai Stock Exchange (SSE), which is segmented from world's other equity markets. We estimate the effects of beta, firm size, book-to-market equity ratio and a variable unique to the Chinese stock markets, the proportion of firm's floating (tradable) equity over total equity on SSE stocks over the period 1993–2002. We find that smaller firms and value stocks perform better. Systematic risk is negatively significant in down markets. The proportion of floating equity has no direct effect on stock returns. JEL Classification: G14, G15     

Tests of technical trading strategies in the emerging equity markets of Latin America and Asia

This study examines the potential profit of ten Variable Length Moving Average (VMA) technical trading rules in ten emerging equity markets in Latin America and Asia from January 1982 through April 1995. The average difference in buy − sell returns after trading costs for each rule and country are compared to a buy and hold strategy. Taiwan, Thailand and Mexico emerge as markets where technical trading strategies may be profitable. We find no strong evidence of profitability for the other markets. However, we find that 82 out of the 100 country–trading rule combinations tested in ten emerging markets, disregarding their statistical significance, correctly predict the direction of changes in the return series. These findings may provide investors with important asset allocation information.     

THE OVERNIGHT AND DAILY TRANSMISSION OF STOCK INDEX FUTURES PRICES BETWEEN MAJOR INTERNATIONAL MARKETS

Stock index futures prices for the world's major equity markets, Japan, the UK and the US, are used to examine the interaction of international equity markets. By using stock index futures prices, we avoid the nonsynchronous data problem inherent with opening and closing market averages. We find that the US is the dominant world market; overnight returns in Japan and the UK are greatly influenced by the US daily returns. In contrast, the Japanese market has no impact on the overnight or daily returns in the UK, while the UK daily performance has a small influence on Japanese overnight returns. Slight evidence of over-reaction at the opening of Japanese futures exists as the daily Nikkei returns are negatively related to the US returns.     

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.     

Commodity Prices and Stock Market Behavior in South American Countries in the Short Run

Using Geweke feedback measures, we present empirical evidence that largely supports the hypothesis that the stock markets of South American countries are highly affected by changes in commodity prices after controlling for changes in exchange rates, interest rates, and North American stock market changes. In total, six different Goldman Sachs commodity price indexes are tested against the unexplained variation in stock market returns for Argentina, Brazil, Chile, Colombia, Peru, and Venezuela, covering the period 1995-2007. The Argentinian, Brazilian, and Peruvian stock markets are significantly affected by changes in commodity prices the same day. Venezuela's stock market, however, does not react to changes in commodity prices, even including energy prices. Stock market returns for Chile show a contemporaneous relation with energy and metals prices, whereas Colombia's equity market is affected by price changes for agricultural and industrial metals. In all cases, we find a contemporaneous relation and no indication of a lead or lag relationship.     

Extreme value theory versus traditional GARCH approaches applied to financial data: a comparative evaluation

Although stock prices fluctuate, the variations are relatively small and are frequently assumed to be normally distributed on a large time scale. But sometimes these fluctuations can become determinant, especially when unforeseen large drops in asset prices are observed that could result in huge losses or even in market crashes. The evidence shows that these events happen far more often than would be expected under the generalised assumption of normally distributed financial returns. Thus it is crucial to model distribution tails properly so as to be able to predict the frequency and magnitude of extreme stock price returns. In this paper we follow the approach suggested by McNeil and Frey in 2000 and combine GARCH-type models with the extreme value theory to estimate the tails of three financial index returns – S&P 500, FTSE 100 and NIKKEI 225 – representing three important financial areas in the world. Our results indicate that EVT-based conditional quantile estimates are more accurate than those from conventional GARCH models assuming normal or Student's t distribution innovations when doing not only in-sample but also out-of-sample estimation. Moreover, these results are robust to alternative GARCH model specifications. The findings of this paper should be useful to investors in general, since their goal is to be able to forecast unforeseen price movements and take advantage of them by positioning themselves in the market according to these predictions.     

Local risk factors in emerging markets: Are they separately priced?

We provide new evidence on the pricing of local risk factors in emerging stock markets. We investigate whether there is a significant local currency premium together with a domestic market risk premium in equity returns within a partial integration asset pricing model. Given previous evidence on currency risk, we conduct empirical tests in a conditional setting with time-varying prices of risk. Our main results support the hypothesis of a significant exchange risk premium related to the local currency risk. Exchange rate and domestic market risks are priced separately for our sample of seven emerging markets. The empirical evidence also suggests that although statistically significant, local currency risk is on average smaller than domestic market risk but it increases substantially during crises periods, when it can be almost as large as market risk. Disentangling these two factors is thus important in tests of international asset pricing for emerging markets.     

The determination and international transmission of stock market volatility

This paper extends the literature on low-frequency analysis of the causes and transmission of stock market volatility. It uses end-monthly data on stock market returns, interest rates, exchange rates, inflation, and industrial production for five countries (Britain, France, Germany, Japan, and the US) from July 1973 to December 1994. Efficient portfolios of world, European, and Japanese/US equity are first constructed, the existence of multivariate cointegrating relationships between them is demonstrated, and the transmission of conditional volatility between them is described. The transmission of conditional volatility from world equity markets and national business cycle variables to national stock markets is then modeled. Among the main findings are: first, world equity market volatility is caused mostly by volatility in Japanese/US markets and transmitted to European markets, and second, changes in the volatility of inflation are associated with changes of the opposite sign in stock market volatility in all markets where a significant effect is found to exist. To the extent that the volatility of inflation is positively related to its level, this implies that low inflation tends to be associated with high stock market volatility.     

Equity market integration in the NAFTA region: Evidence from unit root and cointegration tests

This study examines integration of the three participating equity markets before and after the 1993 passage of NAFTA based on daily, weekly, and monthly data. As expected, unit root tests for the overall period 1988-2001 and the two subperiods, 1988-1993 (pre-NAFTA) and 1994-2001 (post-NAFTA), indicate that stock prices are non-stationary but stock returns are generally stationary for all three markets for all three periods. However, daily, weekly, and monthly equity prices in the three NAFTA countries are cointegrated only for the post-NAFTA period. Similarly, US stock prices are more integrated with both Canadian and Mexican stock prices after the passage of NAFTA. This evidence of increased financial integration and co-movement in NAFTA equity markets after the passage of NAFTA has important implications for policymakers and managers.     

Crisis and Creative Destruction: Cases of Korean and Japanese Stock Markets

In this essay, we investigate the contrasting performance of Korean and Japanese stock markets before and after the East Asian currency crisis. The Korean stock markets showed a sharper decline and a faster recovery than the Japanese stock markets. First, we theoretically explain these contrasting movements of stock markets by explicitly modeling and adding some new elements to the idea of IT revolution in Greenwood and Jovanovic (Amer. Econom. Rev. 89, 1999, 116–122). Then we empirically prove that the theoretical model in this paper has some quantitative support by considering the level of monthly stock market capitalization and the return on daily stock index in Korea and Japan.JEL Classification Code: F43     

基于Copula函数的国际原油价格与股票市场收益的相关性研究

针对国际原油价格与金砖五国股票市场收益之间的相关性问题,使用 AR(p)-GARCH(1,1)-Copula 模型进行检验。运用广义误差分布(GED)获取收益残差序列,对 WTI 原油价格和金砖五国股市收益之间的相关性进行实证分析。研究结果表明,国际原油价格与中国股市收益呈现微弱的相关关系,而与其他四国股市收益的相关关系较为明显。用时变 SJC Copula 模型刻画国际原油价格与金砖五国股票市场收益的相关性最为合适。     

Market Efficiency and the Returns to Simple Technical Trading Rules: New Evidence from U.S. Equity Market and Chinese Equity Markets

Numerous studies in the finance literature have investigated technical analysis to determine its validity as an investment tool. This study is an attempt to explore whether some forms of technical analysis can predict stock price movement and make excess profits based on certain trading rules in markets with different efficiency level. To avoid using arbitrarily selected 26 trading rules as did by Brock, Lakonishok and LeBaron (1992) and later by Bessembinder and Chan (1998), this paper examines predictive power and profitability of simple trading rules by expanding their universe of 26 rules to 412 rules. In order to find out the relationship between market efficiency and excess return by applying trading rules, we examine excess return over periods in U.S. markets and also compare the excess returns between U.S. market and Chinese markets. Our results found that there is no evidence at all supporting technical forecast power by these trading rules in U.S. equity index after 1975. During the 1990s break-even costs turned to be negative, –0.06%, even failing to beat a buy-holding strategyin U.S. equity market. In comparison, our results provide support for the technical strategies even in the presence of trading cost in Chinese stock markets.     

Computing the market price of volatility risk in the energy commodity markets

In this paper, we demonstrate the need for a negative market price of volatility risk to recover the difference between Black–Scholes [Black, F., Scholes, M., 1973. The pricing of options and corporate liabilities. Journal of Political Economy 81, 637–654]/Black [Black, F., 1976. Studies of stock price volatility changes. In: Proceedings of the 1976 Meetings of the Business and Economics Statistics Section, American Statistical Association, pp. 177–181] implied volatility and realized-term volatility. Initially, using quasi-Monte Carlo simulation, we demonstrate numerically that a negative market price of volatility risk is the key risk premium in explaining the disparity between risk-neutral and statistical volatility in both equity and commodity-energy markets. This is robust to multiple specifications that also incorporate jumps. Next, using futures and options data from natural gas, heating oil and crude oil contracts over a 10 year period, we estimate the volatility risk premium and demonstrate that the premium is negative and significant for all three commodities. Additionally, there appear distinct seasonality patterns for natural gas and heating oil, where winter/withdrawal months have higher volatility risk premiums. Computing such a negative market price of volatility risk highlights the importance of volatility risk in understanding priced volatility in these financial markets.     

Asia-Pacific Stock Market Integration: New Evidence by Incorporating Regime Changes

ABSTRACT

This work provides new evidence of Asia-Pacific stock market integration by incorporating the regime changes of each stock market through the smooth transition autoregressive (STAR) model. According to empirical results, most Asia-Pacific stock market returns follow STAR dynamics to a significant degree with more rapid and frequent regime changes of a shorter nature compared with G7 markets. A series of STAR-based Granger causality tests reveal evidence of stronger equity market integration compared with linear Granger causality tests. We also find that Asia-Pacific stock markets are integrated in different levels. Finally, we provide evidence that in the early twenty-first century the influence of China and the United States on Asia-Pacific stock markets has been maintained while that of Japan has been weakened.     

DIVERGENT EXPECTATIONS AND THE ASIAN FINANCIAL CRISIS OF 1997

An important question concerning integration of global financial markets is whether local investors in an equity market react differently from international investors, particularly during periods of financial crisis. Considering local investors are closer to information, they might turn pessimistic before foreign investors before a crisis. We examine whether local investors in each of the six Asian stock markets—Indonesia, Korea, Malaysia, the Philippines, Taiwan, and Thailand—reacted differently from international investors during the 1997 Asian financial crisis. Our empirical results indicate that, in general, closed‐end country fund share prices (mainly driven by foreign investors) Granger‐cause the respective net asset values (NAVs, mainly driven by local investors). Moreover, this one‐way Granger‐causality effect from share prices to NAVs becomes much stronger during the crisis period after controlling for U.S. stock returns. Our results suggest international investors turned pessimistic before local investors. JEL classification: G15     

Long term spread option valuation and hedging

This paper investigates the valuation and hedging of spread options on two commodity prices which in the long run are in dynamic equilibrium (i.e., cointegrated). The spread exhibits properties different from its two underlying commodity prices and should therefore be modelled directly. This approach offers significant advantages relative to the traditional two price methods since the correlation between two asset returns is notoriously hard to model. In this paper, we propose a two factor model for the spot spread and develop pricing and hedging formulae for options on spot and futures spreads. Two examples of spreads in energy markets – the crack spread between heating oil and WTI crude oil and the location spread between Brent blend and WTI crude oil – are analyzed to illustrate the results.     

The Lead‐Lag Relationship Between Cash and Stock Index Futures in a New Market

This paper investigates the lead‐lag relationship in daily returns and volatilities between price movements of the FTSE/ATHEX‐20 and FTSE/ATHEX Mid‐40 stock index futures and the underlying cash indices in the relatively new futures market of Greece. Empirical results show that there is a bi‐directional relationship between cash and futures prices. However, futures lead the cash index returns, by responding more rapidly to economic events than stock prices. This speed is much higher in the more liquid FTSE/ATHEX‐20 market. Moreover, results indicate that futures volatilities spill information over to the corresponding cash market volatilities in both investigated futures markets, but volatilities in the cash markets have no effect on the volatilities of futures markets. Overall, it seems that new market information is disseminated faster in the futures market compared to the stock market. This implies that the futures markets can be used as price discovery vehicles, providing further evidence that derivatives markets contribute to completing and stabilising capital markets in Greece. A further finding of this study is that futures volume and disequilibrium effects between cash and futures prices are important variables in the explanation of volatilities in cash and futures markets.