Idiosyncratic volatility and cross‐sectional stock returns in Southeast Asian stock markets

We examine the role of idiosyncratic risk in five ASEAN markets of Malaysia, Singapore, Thailand, Indonesia, and the Philippines. Our research was motivated by the findings of Ang et al. (2006, 2009) of a ‘puzzling’ negative relation between idiosyncratic volatility and 1‐month ahead stock returns in developed markets and the suggestion of the ubiquity of these results in other markets. In contrast, we find no evidence of an idiosyncratic volatility puzzle in these Asian stock markets; instead, we document a positive relationship between idiosyncratic volatility and returns in Malaysia, Singapore, Thailand, and Indonesia and no relationship in the Philippines. The idiosyncratic volatility trading strategy could result in significant trading profits in Malaysia, Singapore, Thailand, and to some extent in Indonesia. Our study underscores the fact that generalizing empirical results obtained in developed stock markets to new and emerging markets could potentially be misleading.     

The Best of Both Worlds: Accessing Emerging Economies via Developed Markets

A growing body of evidence suggests that the benefits of international diversification via developed markets have declined dramatically. While emerging markets still offer diversification opportunities, their public equity indices capture only a fraction of emerging countries' economic activity. We propose a diversification approach that exploits the global connectedness of developed countries to gain exposure to emerging countries' overall economies rather than their shallow equity markets. In doing so, we demonstrate that developed markets still offer substantial diversification benefits beyond those available through equity indices. Our results suggest that relying on equity indices to assess diversification benefits understates diversification gains.     

The Informational Efficiency of the Equity Market As Compared to the Syndicated Bank Loan Market

The loan market is a hybrid between a public and a private market, comprised of financial institutions with access to private information about borrowing firms. We test whether this is reflected in informationally efficient price formation in the loan market vis-a-vis the equity markets, and reject this private information hypothesis. We also reject a liquidity hypothesis which suggests that equity markets always lead loan markets, despite bank lenders' access to private information, because of greater liquidity in equity markets. We further test, and reject, an asymmetric price reaction hypothesis that states that loan returns are more sensitive to negative information whereas equity returns respond symmetrically to both positive and negative information. We find evidence most consistent with an integrated markets hypothesis that suggests that both the equity and syndicated bank loan markets are highly integrated such that information flows freely across markets. This is particularly true when the equity market makers are also loan syndicate members.      

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.     

Price Formation and Equilibrium Liquidity in Fragmented and Centralized Markets

This paper compares centralized and fragmented markets, such as floor and telephone markets. Risk-averse agents compete for one market order. In centralized markets, these agents are market makers or limit order traders. They are assumed to observe the quotes of their competitors. In fragmented markets they are dealers. They can only assess the positions of their competitors. We analyze differences in bidding strategies reflecting differences in market structures. The equilibrium number of dealers is shown to be increasing in the frequency of trades and the volatility of the value of the asset. The expected spread is shown to be equal in both markets, ceteris paribus. But the spread is more volatile in centralized than in fragmented markets.     

Pricing and Hedging of Multi Type Contracts under Multidimensional Risks in Incomplete Markets Modeled by General Itô SDE Systems

The HARA and CARA theory of pricing, and the theory of partial, yet the most conservative hedging, of a single (liquid) tradable derivative contract under multidimensionality of risks in incomplete markets, including markets with non-hedgable interest rate risks, was developed by the author in a recent paper. In the present paper this theory is extended to the general case of simultaneous pricing and hedging of multiple (types of) such contracts. The results are based on the generalization of the “fundamental matrix of derivatives pricing and hedging” to include multiple contracts. Some applications are discussed as well.     

Information and volatility links in the foreign exchange market

We apply the trading model of Fleming et al (1998 ). to a number of currency markets. The model posits that two markets can have common volatility structures as a result of receiving common information and from cross‐hedging activity where a position in one currency is used to hedge risk in a position taken in another. Our results imply that the model is effective in identifying common information flows and volatility spillovers in the currency markets and that some of these effects are lost when simply examining raw correlations. A series of specification tests of the 21 bivariate systems that are examined provides support for the trading model in the foreign exchange context.     

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.     

A Conditional Assessment of the Relationships between the Major World Bond Markets

This paper uses a bivariate GARCH framework to examine the lead‐lag relations and the conditional correlations between 10‐year US government bond returns and their counterparts from the UK, Germany, and Japan. We find that while mean and volatility spillovers exist between the major international bond markets, they are much weaker than those between equity markets. The results also indicate that the correlations between the US and other major bond market returns are time varying and are driven by changing macroeconomic and market conditions. However, in contrast to the finding that the benefits of international diversification in equity markets evaporate during high‐stress periods, we find that the benefits of diversification across major government bond markets do not decrease during periods of extremely high bond market volatility or following extremely negative US and foreign bond returns.     

An empirical re-examination of the dividend–investment relation

Modigliani and Miller show that, in perfect capital markets, the optimal investment decisions of a firm are not affected by how these investments are financed. Miller and Modigliani further imply that, under the assumption of perfect capital markets, a firm's investment decisions are not affected by its dividend decisions, although dividend decisions may or may not be influenced by investment decisions. Fama and Miller label this result the separation principle. Most recent studies of the separation principle that take into account the existence of market imperfections report sharply contradictory results. This paper tests for linear and nonlinear causality between dividends and investments using both firm-specific and aggregate data for a sample of 417 firms over the 1962 to 2004 period. In general, linear causality tests support the separation principle, whereas nonlinear causality test results contradict the separation principle by revealing strong bi-directional linkages between dividends and investments.     

Call Completeness Implies Completeness in the n-period Model of a Financial Market

In this paper an arbitrage-free n-period model of a financial market with a predictable, strictly positive numéraire and g risky assets is considered. Complete financial markets are of great practical relevance and of considerable theoretical interest, because in these markets one can find hedging strategies and unique arbitrage-free prices. In this paper complete financial markets are characterized by the simple condition of “call-completeness”.     

Covariance and correlation stationarity: Experiences from seven Asian emerging markets

Because of the rising interest and the growing importance of the Asian emerging markets in international diversification, this paper examines the covariance and correlation stationarity in stock return relationships among seven Asian emerging markets. This paper also covers the issue of seasonality in stock return co-movements. Empirical results show that because the correlations among them and those with other developed markets are very small, huge gains from diversifying into the seven Asian emerging markets are possible. Results on stationarity indicate that correlation matrices of stock returns are much more stable then the corresponding variance-covariance matrices and that the length of the estimation period seems to have no impact on the stationarity of the correlation matrix. We also found that virtually no seasonality in the correlations exists among the seven Asian emerging markets. However, we did find that during our sample period covariance among stock returns is nonstationary in January. The author thanks an anonymous referee ofFinancial Engineering and the Japanese Markets for the valuable comments on the earlier version of this article.     

International transmission of information: evidence from the Euroyen and Eurodollar futures markets

This paper examines the information transmission between Japan and the US by using the Tokyo Euroyen and Chicago Eurodollar futures. These two interest rate futures markets provide a better understanding of international information transmission than stock markets, which have been shown to exhibit nonsynchronous trading and market segmentation. The results show that traders in Tokyo (Chicago) use information that is revealed overnight in Chicago (Tokyo). The bivariate EGARCH-t model provides no evidence of volatility spillovers in either direction, suggesting that the opening price rapidly reflects foreign information. The overall results support the hypothesis that the domestic market efficiently adjusts to foreign news. The results are also broadly consistent with the covered interest arbitrage effects.     

The Impact of Terrorist Attacks on International Stock Markets

We examine the effects of terrorist attacks on stock markets, using a dataset that covers all significant events and that directly relate to the major economies of the world. Our event study suggests that terrorist attacks produce mildly negative price effects. We compare these price reactions to those from an alternative type of unanticipated disaster, earthquakes, and find that price declines following terror attacks are more pronounced. However, in both cases prices rebound within the first week of the aftermath. We also compare price responses internationally and for separate industries, and find that reactions are strongest for local markets and for industries that are directly affected by the attack. Our results suggest that financial markets react strongly to terror events but then recover swiftly and soon return to business as usual. The September 11th attacks turn out to be the only event that caused long‐term effects on financial markets, especially in terms of industries' systematic risk.     

Commonality in liquidity: Evidence from the Australian Stock Exchange

Several studies have reported strong evidence of commonality in liquidity in US markets. The present study uses the research design of Chordia et al. (2000) to examine commonality in liquidity for a broad sample of stocks listed on the Australian Stock Exchange (ASX). In contrast to previous research, there is some evidence of market‐wide commonality in liquidity for ASX stocks, but it is less significant and less pervasive than that observed in other markets. These results are consistent with explanations based on differences in market structure between the USA and Australia.     

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.     

Early-warning analysis for currency crises in emerging markets: A revisit with fuzzy clustering

Currency crises, also often called balance-of-payment crises, occur when massive capital outflows force a country to devalue or float its currency. The world-wide integration of capital markets since the 1980s and 1990s has increased the degree of capital mobility, which also determined a substantial turbulence in foreign exchange markets and frequent currency crises. In this paper, we explore advanced supporting instruments for predicting currency crises, based on an empirical study of the currency crisis episodes in 23 emerging markets around the world during the second half of last century. More specifically, we investigate the usefulness of prediction models built based on the fuzzy c-means method. First we build clustering models that partition data into a certain number of overlapping natural groups. Thereafter, we classify the data clusters into early-warning clusters and tranquil clusters. We compare the performance of our models with a conventional c-means clustering model and a benchmark probit model. The results show that the proposed models achieve a similar level of out-of-sample performance as the probit model and c-means model. The fuzzy approach also introduces additional explanatory advantages into the early-warning analysis process. Copyright © 2010 John Wiley & Sons, Ltd.     

Market structure and competitive conditions in the Arab GCC banking system

This paper investigates the market structure of Arab GCC banking industry during the years of 1993–2002 using the most frequently applied measures of concentration k-bank concentration ratio (CRk) and Herfindahl–Hirschman Index (HHI) and evaluates the monopoly power of banks over the ten years period using the ‘H-statistic’ by Panzar and Rosse. The results show that Kuwait, Saudi Arabia and UAE have moderately concentrated markets and are moving to less concentrated positions. The measures of concentration also show that Qatar, Bahrain and Oman are highly concentrated markets. The Panzar–Rosse H-statistics suggest that banks in Kuwait, Saudi Arabia and the UAE operate under perfect competition; banks in Bahrain and Qatar operate under conditions of monopolistic competition; and we are unable to reject monopolistic competition for the banking market in Oman.     

Trust in Financial Markets

This paper examines contemporaneous and historical evidence on the structure of ownership and control of corporate sectors in developed countries to draw lessons for development of financial markets. It records the critical role that equity markets played in the ownership and financing of corporations at the beginning of the 20th century. It notes that this occurred in the absence of formal systems of regulation and that equity markets functioned on the basis of informal relationships of trust. These were sustained through local stock markets in the UK, banks in Germany, and business coordinators and family firms in Japan. The paper explores the concept of trust that is required to promote the development of financial markets.     

Equity Home‐Bias: A Suboptimal Choice for UK investors?

In spite of the popularity of international portfolio diversification theory, extant empirical literature shows that investors prefer domestic assets and as a result, many studies argue that investors' portfolios are largely suboptimal. This paper examines whether British investors need to diversify their portfolios internationally to gain performance benefits from international markets or can they obtain these benefits by mimicking the portfolios with domestically traded assets. The results confirm that it is possible to mimic the performance of foreign equity with domestic equity. Indeed, the pay‐offs from homemade portfolios outperform those from international portfolios regardless of the periodic variation in the overall performance of the UK market vis‐à‐vis foreign markets. The superiority of homemade portfolio is more prominent in recent years and is enhanced by the increased internationalisation of developed capital markets. Therefore, investors' home bias is not suboptimal.