Dynamic linkages between emerging European and developed stock markets: Has the EMU any impact?

This paper investigates the short- and long-run behavior of major emerging Central European (Poland, Czech Republic, Hungary, Slovakia), and developed (Germany, US) stock markets and assesses the impact of the EMU on stock market linkages. Evidence of one cointegration vector in both a pre- and a post-EMU sub-period indicates market comovements towards a stationary long-run equilibrium path. Central European markets tend to display stronger linkages with their mature counterparts, whereas the US market holds a world leading influential role. No dramatic post-EMU shock is detected in stock market dynamics. The empirical findings have important implications for the effectiveness of domestic policy decisions, as the emerging Central European states have recently joined the EU and local stock markets may become less immunized to external shocks.     

The adjustment of credit ratings in advance of defaults

This paper assesses biases in credit ratings and lead–lag relationships for near-to-default issuers with multiple ratings by Moody’s and S&P. Based on defaults from 1997 to 2004, we find evidence that Moody’s seems to adjust its ratings to increasing default risk in a timelier manner than S&P. Second, credit ratings by the two US-based agencies are not subject to any home preference. Third, given a downgrade (upgrade) by the first rating agency, subsequent downgrades (upgrades) by the second rating agency are of greater magnitude in the short term. Fourth, harsher rating changes by one agency are followed by harsher rating changes in the same direction by the second agency. Fifth, rating changes by the second rating agency are significantly more likely after downgrades than after upgrades by the first rating agency. Additionally, we find evidence for serial correlation in rating changes up to 90 days subsequent to the rating change of interest after controlling for rating changes by the second rating agency.     

Forecasting the macroeconomy with contemporaneous financial market information: Europe and the United States

Using Economic Tracking Portfolios (ETP), I find that it is possible to forecast future values of inflation and changes in industrial production in the United States and three core euro countries - Italy, France and Germany - utilizing only current and past financial market information. The longer the forecasting horizon, the better the forecasts based solely on financial market information compared to results from other methods. Of the countries I analyze, the overall forecasting performance of the tracking portfolios is the best for the U.S., and my method outperforms the forecasting performance of a VAR approach.     

Money and liquidity in financial markets

We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the market for liquidity leads banks to engage in what we term “liquidity pull-back,” which involves selling financial assets either by banks directly or by levered investors. Empirical tests on the stock market are supportive. Tighter interbank markets are associated with relatively more volume in more liquid stocks; selling pressure, especially in more liquid stocks; and transitory negative returns. We control for market-wide uncertainty and in the process also contribute to the literature on portfolio rebalancing. Our general point is that money matters in financial markets.     

A spatial analysis of international stock market linkages

We employ spatial econometrics techniques to investigate to what extent countries’ economic and geographical relations affect their stock market co-movements. Among the relations that we analyze, bilateral trade proves to be best suited to capture co-variations in returns. We find a strong effect of a unit shock to three regionally dominant countries, namely the US, the UK, and Japan, on other countries through the trade linkage. The degree of stock market dependence increases and the importance of proximity decreases over time and during recessions. We also analyze several regional crises and find a large impact of Thailand on its trade neighbors during the Asian crisis.     

Efficiency and risk in European banking

We assess the inter-temporal relationship between bank efficiency, capital and risk in a sample of European commercial banks employing several definitions of efficiency, risk and capital and using the Granger-causality methodology in a panel data framework. Our results suggest that lower bank efficiency with respect to costs and revenues Granger-causes higher bank risk and that increases in bank capital precede cost efficiency improvements. We also find that more efficient banks eventually become better capitalized and that higher capital levels tend to have a positive effect on efficiency levels. These results are generally confirmed by a series of robustness tests. The results have potentially important implications for bank prudential supervision and underline the importance of attaining long-term efficiency gains to support financial stability objectives.     

Sovereign credit spreads

The paper develops a structural credit risk model to study sovereign credit risk and the dynamics of sovereign credit spreads. The model features endogenous default and recovery rates that both depend on the interaction between domestic output fluctuations and global macroeconomic conditions. We show that sovereigns choose to default at higher levels of economic output once global macroeconomic conditions are bad. This yields to default rates and credit spreads that are substantially higher compared to normal times. We derive closed-form expressions for sovereign debt values and default times and focus on the dynamics of sovereign credit spreads. As opposed to standard theories of sovereign debt, this paper’s structural model generates much richer default patterns and non-linearities through regime-shifts in the global macroeconomic environment. Moreover, changes in the global environment reveal the interconnectedness of the financial system.     

An unobserved component model of asset pricing across financial markets

Our research focuses on multifactor asset pricing models that investigate the importance of economic factors in the pricing of assets beyond the scope of the stock market. We present a Bayesian learning model of asset pricing across financial markets in which unobserved components are estimated using a Kalman filter (KF). Economic factors serve to drive the pricing of risk in the market, and agents update expectations recursively, as new information becomes available. We generally find that the Kalman filter provides superior performance and that economic factors like industrial production and unanticipated inflation provide consistent implications across financial markets.     

ESG in credit ratings and the impact on financial markets

This study examines environment, social, governance (ESG) consideration in rating reports published by credit rating agencies. 3,719 Moody's credit rating reports between 2004 and 2015 are examined and the ESG consideration is analyzed using a latent dirichlet allocation (LDA) approach. We further analyze the stock returns and credit default swap (CDS) spread changes to check whether ESG consideration has an effect on the capital market reactions. We find a small but present consideration of ESG in rating decisions. Within ESG, corporate governance plays the most important role. Moreover, the results reveal that ESG consideration is a significant determinant in the stock return and CDS spread around the rating announcement. We find that all ESG criteria are important for equity and debt investors.     

Corporate credit risk modeling and the macroeconomy

Despite a surge in the research efforts put into modeling credit and default risk during the past decade, few studies have incorporated the impact that macroeconomic conditions have on business defaults. In this paper, we estimate a duration model to explain the survival time to default for borrowers in the business loan portfolio of a major Swedish bank over the period 1994–2000. The model takes both firm-specific characteristics, such as accounting ratios and payment behaviour, loan-related information, and the prevailing macroeconomic conditions into account. The output gap, the yield curve and consumers’ expectations of future economic development have significant explanatory power for the default risk of firms. We also compare our model with a frequently used model of firm default risk that conditions only on firm-specific information. The comparison shows that while the latter model can make a reasonably accurate ranking of firms’ according to default risk, our model, by taking macro conditions into account, is also able to account for the absolute level of risk.     

Granger-causality in peripheral EMU public debt markets: A dynamic approach

Our research aims to analyze the possible existence of Granger-causal relationships in the behavior of public debt issued by peripheral member countries of the European Economic and Monetary Union (EMU), with special emphasis on the recent episodes of crisis triggered in the eurozone sovereign debt markets since 2009. With this goal in mind, we make use of a database of daily frequency of yields on 10-year government bonds issued by five EMU countries (Greece, Ireland, Italy, Portugal and Spain), covering the entire history of the EMU from its inception on 1 January 1999 until 31 December 2010. In the first step, we explore the pair-wise Granger-causal relationship between yields, both for the whole sample and for changing subsamples of the data, in order to capture the possible time-varying causal relationship. This approach allows us to detect episodes of significant increase in Granger-causality between yields on bonds issued by different countries. In the second step, we study the determinants of these episodes, analyzing the role played by different factors, paying special attention to instruments that capture the total national debt (domestic and foreign) in each country.     

The cross section of conditional mutual fund performance in European stock markets

This paper implements strategies that use macroeconomic variables to select European equity mutual funds, including Pan-European, country, and sector funds. We find that several macro-variables are useful in locating funds with future outperformance and that country-specific mutual funds provide the best opportunities for fund rotation strategies using macroeconomic information. Specifically, our baseline long-only strategies that exploit time-varying predictability provide four-factor alphas of 12–13% per year over the 1993–2008 period. Our study provides new evidence on the skills of local versus Pan-European asset managers, as well as how macroeconomic information can be used to locate and time these local fund manager skills.     

Leads and lags in sovereign credit ratings

This paper analyses lead–lag relationships in sovereign ratings across five agencies, and finds evidence of interdependence in rating actions. Upgrade (downgrade) probabilities are much higher, and downgrade (upgrade) probabilities are much lower for a sovereign issuer with a recent upgrade (downgrade) by another agency. S&P tends to demonstrate the least dependence on other agencies, and Moody’s tends to be the first mover in upgrades. Rating actions by Japanese agencies tend to lag those of the larger agencies, although there is some evidence that they lead Moody’s downgrades.     

Do industries lead stock markets?

We investigate whether the returns of industry portfolios predict stock market movements. In the US, a significant number of industry returns, including retail, services, commercial real estate, metal, and petroleum, forecast the stock market by up to two months. Moreover, the propensity of an industry to predict the market is correlated with its propensity to forecast various indicators of economic activity. The eight largest non-US stock markets show remarkably similar patterns. These findings suggest that stock markets react with a delay to information contained in industry returns about their fundamentals and that information diffuses only gradually across markets.     

The effects of tax policy on financial markets: G3 evidence

We investigate the effects of various tax policy innovations on stock market returns. By using a vector autoregressive model that controls for the mutual causality between fiscal policy and financial market performance, we test whether financial markets serve as a transmission mechanism for tax policy innovations. Our findings indicate that indirect taxes have a larger effect on market returns than do labor taxes. Further, corporate tax innovations do not have any statistically significant effect on stock returns. We consider that this finding is a result of a firm's ability to switch between equity financing and bond financing.     

U.S. investors and global equity markets

This study examines international equity flows of U.S. residents to emerging markets in Latin America and Asia and to developed markets in Europe, Canada, and Japan. The major issues addressed are (1) appropriate means of measuring relationships between returns and flows, (2) role of volatility in these relationships, and (3) effects of the Asian crisis. Basic findings include: (1) the information contribution argument is stronger than the feedback trading argument (flows affect returns more than past returns affect flows), (2) volatility of flows and of returns are not of major importance, (3) the Asian crisis effects are important and strongest for Asia followed by developed markets and by Latin America, and (4) regional measures and U.S. returns play significant roles in international equity flows to many countries.     

The comovement of US and German bond markets

We use a vector-autoregression, with parameter estimates corrected for small-sample bias, to decompose US and German unexpected bond returns into three ‘news’ components: news about future inflation, news about future real interest rates, and news about future excess bond returns (term premia). We then cross-country correlate these news components to see which component is responsible for the high degree of comovement of US and German bond markets. For the period 1975-2003 we find that inflation news is the main driving force behind this comovement. When news is coming to the US market that future US inflation will increase, there is a tendency that German inflation will also increase. This is regarded bad news for the bond market in both countries whereby bond prices are bid down leading to immediate negative return innovations and changing expectations of future excess bond returns. Thus, comovement in expected future inflation is the main reason for bond market comovement.     

Stock market reaction to fed funds rate surprises: State dependence and the financial crisis

This paper examines the response of US stock returns to Federal Funds rate (FFR) surprises between 1989 and 2012, focusing on the impact of the recent financial crisis. We find that outside the crisis period, stock prices increased as a response to unexpected FFR cuts. State dependence is identified with stocks exhibiting larger increases when interest rate easing coincided with recessions, bear markets, and tightening credit conditions. However, an important structural shift occurred during the crisis, changing the stocks’ response to FFR shocks and the nature of state dependence. Throughout the crisis period, stocks did not react positively to unexpected FFR cuts, which were interpreted as signals of worsening future economic conditions. This triggered a rebalancing of investment portfolios away from falling equities and towards safe-haven assets. Our results highlight the severity of the crisis and the ineffectiveness of conventional monetary policy close to the zero lower bound.     

Changing integration of EMU public property markets

This paper examines the impact of the European Monetary Union (EMU) on European public property market integration. Results indicate that the property markets are long-run independent and show little evidence of short-run relationships prior to the formation of the EMU. However, the degree of interdependence and the extent of convergence among the largest property markets have intensified substantially after the launch of the Euro as the common currency in January, 1999. Moreover, each of the property markets under consideration is endogenous in that none is found to “dominate” the others toward long-run equilibrium. Short-run results indicate substantial interrelationships among the markets after the adoption of the Euro. Finally, the study shows that stock markets, bond markets, and public property markets follow similar convergence patterns.     

EMU and European government bond market integration

In this study we adopt the CAPM-based model of Bekaert and Harvey (1995) to compare the differences in the relative importance of two sources of systemic risk (world and Eurozone) on Government bond returns, in two groups of countries in EU-15. Results show that euro markets are less vulnerable to the influence of world risk factors, and more vulnerable to EMU risk factors. However, they are only partially integrated. For their part, the markets of the countries that decided to stay out of the Monetary Union present a higher vulnerability to external risk factors.