Why does bad news increase volatility and decrease leverage?

A recent literature shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility, that is, it assumes an inverse relationship between first and second moments of asset returns. This paper suggests a reason why bad news is more often than not associated with higher future volatility. We show that, in a model with endogenous leverage and heterogeneous beliefs, agents have the incentive to invest mostly in technologies that become more volatile in bad times. Agents choose these technologies because they can be leveraged more during normal times. Together with the existing literature this explains pro-cyclical leverage. The result also gives a rationale to the pattern of volatility smiles observed in stock options since 1987. Finally, the paper presents for the first time a dynamic model in which an asset is endogenously traded simultaneously at different margin requirements in equilibrium.     

Global idiosyncratic risk moments

We investigate a global cross-sectional relation between idiosyncratic risk moments and expected stock returns by suggesting three global idiosyncratic volatility, skewness, and kurtosis risk factors. We also suggest two global small minus big and high minus low risk proxies for estimating return residuals of the test assets from a global asset pricing model. To perform robustness checks, we suggest other four global risk factors of momentum, leverage, bid-ask spread, and liquidity. We find a significant negative relation between stock portfolio returns and the global moments, and the cross section of stock returns reflects a significant negative price of risk for global idiosyncratic skewness (?0.13%) and idiosyncratic volatility (?1.85%) and a positive and significant price of risk for global idiosyncratic kurtosis. We find that our suggested risk factors are key drivers of risk premia in stock market and are robust to various checks. These factors also can forecast the gross domestic product growth over the sample period.     

Performance and diversification benefits of foreign-equity ETFs in emerging markets

This study provides a comprehensive review of the risk-return characteristics, performance and international diversification benefits of an uncharted fast-growing segment of the global exchange-traded fund (ETF) market by examining 17 foreign-equity ETFs traded in 6 emerging markets. The results indicate that the sample ETFs domiciled in these economies perform poorly providing relatively low returns while exposing emerging market investors to substantial total and systematic risks. In addition, these ETFs are found to be more sensitive to downside risk, making them relatively more vulnerable to market downturns. Although the foreign-equity ETFs are designed to provide investors with full international diversification benefits, we find that they are significantly affected by their local market conditions and sentiments, making them ineffective international diversification tools.     

Liquidity default,liquidity management and smooth dividends policy

Our article models liquidity financing constraints with the real options framework. By conducting a comprehensive investigation of the effects of shocks to liquidity constraints on the firm’s optimal investment, financing and dividend policies, our model highlights the importance of liquidity management and extends the liquidity management approach to hedge liquidity default risk. We find that being concerned about liquidity default risk will significantly change a firm’s behaviours, including those related to investment and the optimal capital structure. A firm that is concerned about its liquidity default risk will become more cautious: it will choose to delay investment and have higher leverage when internal liquidity is very low, but choose earlier investment and lower leverage when liquidity is high enough. The dividends policy can alleviate risks from both the external market and internal project volatility and provides an alternative explanation for the ‘smooth dividends policy puzzle’ commonly reported in empirical research.     

Empirical Evidence of the Leverage Effect in a Stochastic Volatility Model: A Realized Volatility Approach

Increasing attention has been focused on the analysis of the realized volatility, which can be treated as a proxy for the true volatility. In this paper, we study the potential use of the realized volatility as a proxy in a stochastic volatility model estimation. We estimate the leveraged stochastic volatility model using the realized volatility computed from five popular methods across six sampling-frequency transaction data (from 1-min to 60- min) based on the trust region method. Availability of the realized volatility allows us to estimate the model parameters via the MLE and thus avoids computational challenge in the high dimensional integration. Six stock indices are considered in the empirical investigation. We discover some consistent findings and interesting patterns from the empirical results. In general, the significant leverage effect is consistently detected at each sampling frequency and the volatility persistence becomes weaker at the lower sampling frequency.     

The heterogeneous volume-volatility relations in the exchange-traded fund market: Evidence from China

We decompose the trading volume of exchange-traded funds (ETFs) into specific components according to different triggers of trades: (i) private information, (ii) disagreement among investors due to their different opinions on public information or having different information, and (iii) investor impatience. Then we examine the particular impact of each type of ETF trade on the market volatility of the tracked index. Focusing on the three ETFs tracking the CSI 300, we show that ETF trades stemming from investor disagreement are a key determinant of CSI 300 volatility, dominating other factors considered. Liquidity ETF trades can partially explain CSI 300 volatility. However, little evidence supports a significant correlation between privately informed trades of ETFs and CSI 300 volatility.     

中国公司债券的信用利差与流动性风险

利用主成分分析法构造公司债券流动性风险测度指标,引入M-Copula函数和Markov机制转换模型实证分析中国公司债券的流动性风险与信用利差的关系。结果表明,M-Copula函数与Markov机制转换模型的实证结果一致。具体如下:公司债券的流动性风险对信用利差的影响是一个动态的非线性过程;两者之间存在显著的非对称尾部相关性,其中上尾相关性较高,即熊市时期流动性风险和信用利差同时增大的概率高于牛市时期,且熊市时期流动性风险对信用利差的影响程度显著高于其他时期。     

How changes in global liquidity affect dynamics of banks’ leverage: A case in Hong Kong

This paper examines how abundant global liquidity could influence the adjustment of banks’ leverage. Using banks in Hong Kong as an example, we find that the global liquidity effect is significant, and that mean reversion of banks’ leverage may under certain circumstances be more than offset by abundant global liquidity. Furthermore, we find that changes in global liquidity not only affect the level of leverage adjustment but also the adjustment speed of banks’ leverage.     

中美股市杠杆效应与波动溢出效应——基于GARCH模型的实证分析

本文基于极大似然函数值准则和赤池信息准则,从众多非对称GARCH模型中选择最优模型来研究中美股市杠杆效应和波动溢出效应。结果表明:沪市和深市都表现出显著的杠杆效应,与美国股市相比沪市和深市杠杆效应较弱;沪市和深市之间存在显著的双向波动溢出效应,且沪市对深市的波动溢出效应更显著;美国股市与中国股市之间不存在显著的波动溢出效应。     

Is market liquidity less resilient after the financial crisis? Evidence for US Treasuries

Understanding market liquidity resilience, i.e. the capacity of liquidity to absorb shocks, of United States Treasuries is crucial from a financial stability standpoint. The conventional resilience measure has limitations due to the use of the liquidity level. We propose a new complementary approach to analyze resilience based on liquidity volatility. For this purpose, we focus on the link between returns volatility and liquidity volatility, which is a relatively unexplored field. We fit a bivariate conditional correlation (CC-) GARCH model for the 10-year bond returns and five liquidity indicators from January 2003 to June 2016 to analyze persistence and spillovers between these variables in a parsimonious way. We find that after the crisis, spillovers between liquidity volatility and returns volatility are higher, feedback loops are more likely and volatility persistence is lower, which is consistent with a lower resilience. Our results help to explain recent episodes of high volatility in this market.     

Concentration and Liquidity in Mature Markets: Evidence from the US Dollar/Yen Futures Market

The cost of liquidity is the major cost of transacting on organised futures exchanges. Liquidity has value both to traders and to exchanges. This paper argues that liquidity varies directly with market development, and that this relationship provides a major incentive for mergers among exchanges. While previous research on liquidity has focused on spot markets for a range of securities, this paper employs data from the US dollar/Yen futures contract to investigate the relationship between liquidity and volume, between liquidity, volume and volatility, and between liquidity and the speculation ratio. The paper tests for non–linearity in these relationships, and explores the presence of Granger causality between pairs of key variables.
The results include inter alia the presence of a significant negative relationship between the cost of liquidity and volume, and evidence of a significant non–linear relationship in which the cost of liquidity varies directly with volatility and negatively with the conditional fourth moment about the mean of daily prices (a measure of kurtosis). Moreover, there is evidence that liquidity Granger causes volume, that volatility Granger causes volume, and that liquidity Granger causes the speculation ratio.     

Non-linearity in the determinants of capital structure: evidence from UK firms

We demonstrate that, by exploiting more fully the distribution of leverage, conditional quantile regression methods yield new insights into the choice of leverage ratio. For UK listed companies we find that not only is the estimated effect of the explanatory variables different at different quantiles of the distribution, but also that the effect of a variable changes sign between low leveraged and high leveraged firms.      

What are the bank-specific and macroeconomic drivers of banks’ leverage? Evidence from Luxembourg

We investigate the leverage cycle in Luxembourg’s banking sector using individual bank-level data for the period 2003 Q1–2010 Q1. One of our findings is that Luxembourg’s banks have a procyclical leverage. This procyclicality is not due to marking-to-market but because Luxembourg’s banks are liquidity providers to the EU banking sector. We then empirically investigate the role of bank characteristics as well as real, financial and expectation variables that proxy for macroeconomic conditions in the pre-crisis and crisis period. We find that off-balance sheet exposures have different effects in the pre-crisis and crisis period, and that the share of liquid assets in the portfolio only affects security holdings. As for macroeconomic variables, we find that the Euribor-OIS spread is a significant driver of the build-up in leverage in the pre-crisis period. The reason is that most banks in Luxembourg are either branches or subsidiaries. This makes leverage a less relevant indicator of riskiness for investors. It also implies that in times of liquidity shortages, mother companies or groups demand further liquidity from their branch or subsidiary. The downturn in leverage during the crisis can be accredited to reductions in expectations, which we proxy by an economic sentiment indicator. It can also be explained by increasing bond prices which induce depositors to shift their funds from bank deposits into bonds. We find no important role for GDP growth.     

Macroeconomic implications of financial policy

This paper studies the effects of financial policy in a model with heterogeneous agents, incomplete markets and portfolio restrictions. For an economy calibrated to replicate key aspects of the U.S. wealth distribution, we find that the quantitative effects of financial policy are relatively small. The reason is that the households determining aggregate behavior are relatively well insured and can therefore offset the actions of the firm by modifying their portfolio allocations. However, financial policy has important effects on asset prices. Whereas a higher level of debt in the capital structure of the firm introduces more risk into the economy by increasing the volatility of the equity return, it enhances the liquidity of households by increasing the supply of bonds. In an economy with a substantial amount of heterogeneity, this last effect dominates and leverage leads to a decrease in the equity premium. This is in contrast to the findings in representative agent models, in which leverage unambiguously increases the premium through a higher equity return volatility.     

An analysis of the spillover effects of exchange-traded funds

This article used the Generalized Autoregressive Conditional Heteroscedasticity-Autoregressive Moving Average (GARCH-ARMA) and the exponentially Generalized Autoregressive Conditional Heteroscedasticity-Autoregressive Moving Average (EGARCH-ARMA) models to study the impact of the spillover and the leverage effects on returns and volatilities of stock index and Exchange Trade Fund (ETF) for developed and emerging markets. Previous unexpected returns for developed and emerging markets which have an opposite influence pattern on ETFs’ returns were identified. The spillover effects from returns are excellent for Hong Kong, followed by Singapore. Meanwhile, Taiwan's stock index return was recorded to have a strong negative impact on ETF return. Notably, this article shows that the spillover effects on stock index and ETF volatilities existed with bilateral influences. Despite a strong positive asymmetric volatility effect in Korea's ETF market, the leverage effect appears to play important roles in the explanation of both stock index and ETF returns.     

Where does return and volatility come from? The case of Asian ETFs

We analyze return and volatility of Asian iShares traded in the U.S. The difference in trading schedules between the U.S. and Asia offers a unique market setting that allows us to distinguish various return and volatility sources. We find Asian ETFs have higher overnight volatility than daytime volatility, explained by public information released during each local market's trading session. Local Asian markets also play an important role in determining each Asian ETF return. Nonetheless, returns for these funds are highly correlated with U.S. markets, indicative of the effects of investor sentiment and location of trade. Finally, returns in the U.S. market Granger-cause returns in all six Asian markets are analyzed.     

Volatility and trading activity in Short Sterling futures

The objective of the present study is to examine the interplay between information, trading volume and volatility in Short Sterling futures. More specifically, the paper concentrates on the role of liquidity variables as conduits of information arrival and whether such variables could be an exclusive platform of the market's information set. The analytical framework employed to examine the interaction among those factors is based on the conditional volatility family of techniques. The approach is well suited as it naturally leads to examine the interaction among volatility and sources of information. In an attempt to identify proxies of information and their role in determining volatility, four main conclusions have emerged. First, the empirical findings suggest that both volume and open interest exhibit a positive correlation with volatility. Second, based on the current methodology, one can observe the persistence and importance of GARCH effects after accounting for liquidity. Third, the liquidity variables remain significantly exogenous compared with other studies. Finally, although both liquidity variables are found significant, their role as vehicles of transmitting information is proved to be weak with respect to the information itself.     

Cash management in the travel and leisure sector: evidence from the United Kingdom

This study investigates the determinants of cash holdings for companies operating in the travel and leisure (TL) sector of the United Kingdom (UK) between 2005 and 2016. The study finds that growth opportunities, cash flow, and cash flow volatility affect cash holdings positively, while size, leverage, liquidity, asset intangibility and dividend payments affect negatively. Companies operating in the airlines sub-sector hold more cash, while companies in the hotels and restaurants and bars sub-sectors hold less cash than the reference sub-sector of travel and tourism. Except for the free cash flow model, the trade-off and pecking order models of cash holdings are empirically supported for the TL sector.     

中国公司债券交易量与价格波动的关系

使用中国沪深证券交易所的公司债数据,检验了债券交易量与价格波动的线性关系和非线性尾部相关性,分析了债券流动性水平对量价关系的影响,研究了债券量价关系的时变特征。结果表明:中国公司债市场中债券交易量与价格波动之间存在显著的线性关系;债券流动性水平对量价关系有显著影响,债券流动性水平越高(低),则量价关系越弱(强);债券交易量与价格波动存在非对称的下尾相关性;债券量价关系具有时变性,市场低风险时期量价关系较弱,市场高风险时期量价关系较强。     

Testing the effect of technical analysis on market quality and order book dynamics

We find empirical support for the theoretical finding in agent-based models of limit order book markets that the effect of technical trading on market quality is not positive. When signals occur, technical traders lower liquidity as proxied by the relative spread, the effective spread, the realized spread, the dispersion and the slope in the order book. Technical trading is also found to be accompanied by rising volatility. There is overall strong empirical support against the hypothesis that technical trading has no effect on order book dynamics.