The bull and bear market model of Huang and Day: Some extensions and new results

We develop a financial market model with interacting chartists and fundamentalists that embeds the famous bull and bear market model of Huang and Day as a special case. Their model is given by a one-dimensional continuous piecewise-linear map. Our model, on the other hand, is more flexible and is represented by a one-dimensional discontinuous piecewise-linear map. Nevertheless, we are able to provide a more or less complete analytical treatment of the model dynamics by characterizing its possible outcomes in parameter space. In addition, we show that quite different scenarios can trigger real-world phenomena such as bull and bear market dynamics and excess volatility.     

Equilibrium price dynamics in an overlapping-generations exchange economy

An extension to the Yaari (1965)–Blanchard (1985) continuous time overlapping generations model for an endowment Arrow–Debreu economy with an age-structured population is presented. It is proved that Arrow–Debreu equilibrium prices are represented by a double linear integral equation, and depend on the age-distributions of population and endowments. For an economy with a balanced growth, and logarithmic utility, we prove that bubbles may exist if endowments are distributed earlier than some critical age.     

The affine arbitrage-free class of Nelson-Siegel term structure models

We derive the class of affine arbitrage-free dynamic term structure models that approximate the widely used Nelson-Siegel yield curve specification. These arbitrage-free Nelson-Siegel (AFNS) models can be expressed as slightly restricted versions of the canonical representation of the three-factor affine arbitrage-free model. Imposing the Nelson-Siegel structure on the canonical model greatly facilitates estimation and can improve predictive performance. In the future, AFNS models appear likely to be a useful workhorse representation for term structure research.     

Variance trading and market price of variance risk

This paper develops a new approach for variance trading. We show that the discretely-sampled realized variance can be robustly replicated under very general conditions, including when the price can jump. The replication strategy specifies the exact timing for rebalancing in the underlying. The deviations from the optimal schedule can lead to surprisingly large hedging errors. In the empirical application, we synthesize the prices of the variance contract on S&P 500 index over the period from 01/1990 to 12/2009. We find that the market variance risk is priced, its risk premium is negative and economically very large. The variance risk premium cannot be explained by the known risk factors and option returns.     

Strategy switching in the Japanese stock market

This paper investigates the expectation formation process of Japanese stock market professionals. By utilizing a monthly forecast survey dataset on the TOPIX distributed by QUICK Corporation, we sort forecasters into buy-side and sell-side professionals. We empirically demonstrate that the buy-side and sell-side professionals use either fundamental or trend-following strategies throughout their expectation formation processes and that they switch between fundamental and trend-following strategies over time. We also discuss that strategy switching can be key in understanding the persistent deviation of the TOPIX from the fundamentals.     

The J-curve dynamics of U.S. bilateral trade

Three earlier studies examined the impact of dollar depreciation on bilateral trade between the United States and her six largest trading partners. They used different methodologies that resulted in different outcomes. In this paper we consider 18 major trading partners of the United States and employ a relatively new method to investigate the short-run as well as the long-run response of the bilateral trade balance to currency depreciation. While as with previous research we are unable to discover any J-curve pattern in the short run, in the long run real depreciation of the dollar has favorable effects on the U.S. trade balance in most cases. Valuable comments of an anonymous referee are greatly appreciated. Any remaining errors, however, are the authors'.     

Cost of equity for Canadian and U.S. sectors

A two-stage CAPM approach is used to generate cost-of-equity estimates and sources of their uncertainty for 10 GICS sectors in Canada and the U.S. under the assumption of relatively integrated North American economies and equity markets. The estimated cost of equity for the Canadian sectors is, on average, about the same as that of the U.S. sectors, but with a higher estimation error. The estimation error of the market risk premium is the most important uncertainty component for the equity cost estimates, except for Canadian Utilities where beta uncertainty is the most important component. Beta and interaction effects play a relatively more important role in Canada due to relatively more volatile sector betas in Canada. Our study suggests that: (1) Canadian cost of equity should be estimated in an integrated market rather than a segmented market and (2) higher importance should be given to estimating the dynamics of betas for the Canadian sectors.     

Jumps in equilibrium prices and market microstructure noise

Asset prices observed in financial markets combine equilibrium prices and market microstructure noise. In this paper, we study how to tell apart large shifts in equilibrium prices from noise using high frequency data. We propose a new nonparametric test which allows us to asymptotically remove the noise from observable price data and to discover jumps in fundamental asset values. We provide its asymptotic distribution to decide when such jumps occur. In finite samples, our test offers reasonable power for distinguishing between noise and jumps. Empirical evidence indicates that it is necessary to incorporate the presence of jumps in equilibrium prices.     

Increasing the price variation in a repeated cross section

Insufficient price variation seriously hampers many applications of consumer demand models. This paper examines the empirical performance of a potential remedy for this problem that was suggested by [Lewbel, A., 1989. Identification and estimation of equivalence scales under weak separability. Review of Economic Studies 56, 311–316], the construction of individual specific price indices for bundles of goods. These individual specific price indices allow for a population with heterogeneity in preferences for goods within a given bundle of goods. We confine ourselves to heterogeneous Cobb Douglas within bundle preferences, while between bundles, we allow for several parametric and even general nonparametric specifications. In a variety of settings, we show that such prices produce superior empirical results than the ones obtained through the traditional practice of using aggregate price indices. Our empirical analysis is based on the British Family Expenditure Survey data, and uses several categories of food. Both in parametric as well as nonparametric models, we obtain higher precision of estimates for parameters or functions, as well as economically more plausible results.     

Risk,jumps, and diversification

We test for price discontinuities, or jumps, in a panel of high-frequency intraday stock returns and an equiweighted index constructed from the same stocks. Using a new test for common jumps that explicitly utilizes the cross-covariance structure in the returns to identify non-diversifiable jumps, we find strong evidence for many modest-sized, yet highly significant, cojumps that simply pass through standard jump detection statistics when applied on a stock-by-stock basis. Our results are further corroborated by a striking within-day pattern in the significant cojumps, with a sharp peak at the time of regularly scheduled macroeconomic news announcements.     

Semi-nonparametric estimation of the call-option price surface under strike and time-to-expiry no-arbitrage constraints

We suggest a semi-nonparametric estimator for the call-option price surface. The estimator is a bivariate tensor-product B-spline. To enforce no-arbitrage constraints across strikes and expiry dates, we establish sufficient no-arbitrage conditions on the control net of the B-spline surface. The conditions are linear and therefore allow for an implementation of the estimator by means of standard quadratic programming techniques. The consistency of the estimator is proved. By means of simulations, we explore the statistical efficiency benefits that are associated with estimating option price surfaces and state-price densities under the full set of no-arbitrage constraints. We estimate a call-option price surface, families of first-order strike derivatives, and state-price densities for S&P 500 option data.     

Private debt, unused credit lines, and seasoned equity offerings

We study a sample of SEOs to examine the impact of private debt and unused credit lines on SEO underpricing and long-run stock and operating performance. We do not find significant effects of private debt financing on SEO underpricing and long-run stock underperformance. However, firms with more bank debt and unused lines of credit exhibit significantly better pre-issue operating performance. Changes in operating performance from the pre-issue year to the post-issue period are negatively related to the size of unused credit lines. Capital spending decreases with the size of unused credit lines in the year prior to SEOs, but increases following SEOs. Our overall evidence suggests that the post-issue operating performance we observed may be a result of overinvestment, which is enhanced by unused credit lines.     

Stale and Scale Effects in Markets-Based Accounting Research: Evidence from the Valuation of Dividends

Abstract

This study revisits prior research on the valuation of dividends in an accounting-based valuation framework. Using a battery of tests, we show that market value deflation is essential in market-based tests of dividend displacement and signalling because it controls for ‘stale’ information in addition to scale (size) differences across firms. For US firms, we show that after controlling for ‘stale’ information, the empirical association between dividends and market values switches from positive to negative. This switch is not explained by scale differences across firms. Further, we show that after controlling for staleness, the valuation of dividends remains positive for European firms. This result is explained by the relatively stronger association of dividends with future earnings in these settings (i.e. signalling). Lastly, our country-specific estimates of dividend valuation provide a potentially valuable index for studies aimed at examining the effects of accounting and securities regulation on information asymmetries in an international context.     

Jump tails,extreme dependencies,and the distribution of stock returns

We provide a new framework for estimating the systematic and idiosyncratic jump tail risks in financial asset prices. Our estimates are based on in-fill asymptotics for directly identifying the jumps, together with Extreme Value Theory (EVT) approximations and methods-of-moments for assessing the tail decay parameters and tail dependencies. On implementing the procedures with a panel of intraday prices for a large cross-section of individual stocks and the S&P 500 market portfolio, we find that the distributions of the systematic and idiosyncratic jumps are both generally heavy-tailed and close to symmetric, and show how the jump tail dependencies deduced from the high-frequency data together with the day-to-day variation in the diffusive volatility account for the “extreme” joint dependencies observed at the daily level.     

Monetary policy regimes and the term structure of interest rates

US monetary policy is investigated using a regime-switching no-arbitrage term structure model that relies on inflation, output, and the short interest rate as factors. The model is complemented with a set of assumptions that allow the dynamics of the private sector to be separated from monetary policy. The monetary policy regimes cannot be estimated if the yield curve is ignored during estimation. Counterfactual analysis evaluates importance of regimes in policy and shocks for the great moderation. The low-volatility regime of exogenous shocks plays an important role. Monetary policy contributes by trading off asymmetric responses of output and inflation under different regimes.     

A Bayesian approach to bandwidth selection for multivariate kernel regression with an application to state-price density estimation

This paper presents a Bayesian approach to bandwidth selection for multivariate kernel regression. A Monte Carlo study shows that under the average squared error criterion, the Bayesian bandwidth selector is comparable to the cross-validation method and clearly outperforms the bootstrapping and rule-of-thumb bandwidth selectors. The Bayesian bandwidth selector is applied to a multivariate kernel regression model that is often used to estimate the state-price density of Arrow–Debreu securities with the S&P 500 index options data and the DAX index options data. The proposed Bayesian bandwidth selector represents a data-driven solution to the problem of choosing bandwidths for the multivariate kernel regression involved in the nonparametric estimation of the state-price density pioneered by Aït-Sahalia and Lo [Aït-Sahalia, Y., Lo, A.W., 1998. Nonparametric estimation of state-price densities implicit in financial asset prices. The Journal of Finance, 53, 499, 547.]     

Time-varying jump tails

We develop new methods for the estimation of time-varying risk-neutral jump tails in asset returns. In contrast to existing procedures based on tightly parameterized models, our approach imposes much fewer structural assumptions, relying on extreme-value theory approximations together with short-maturity options. The new estimation approach explicitly allows the parameters characterizing the shape of the right and the left tails to differ, and importantly for the tail shape parameters to change over time. On implementing the procedures with a panel of S&P 500 options, our estimates clearly suggest the existence of highly statistically significant temporal variation in both of the tails. We further relate this temporal variation in the shape and the magnitude of the jump tails to the underlying return variation through the formulation of simple time series models for the tail parameters.