Similarity of emerging market returns under changing market conditions: Markets in the ASEAN-4, Latin America,Middle East,and BRICs

We studied the risk-return distances of 18 emerging stock markets in the period from January 2000 to December 2013. Distances are linked to volatility and time-varying correlations estimated in standard and asymmetric DCC models. Our results revealed a positive relationship between risk-return distances and volatility, which means that during more volatile periods, the risk-return characteristics in emerging markets exhibit lower similarity to the characteristics found in developed markets. This result seems to be in sharp contrast to most empirical studies using correlations. Within the portfolio framework, our results suggest that diversification into emerging stock markets may still provide desirable benefits to international investors.     

The benefits of international diversification: Re-examining the effect of market allocation constraints

This paper makes adjustments to the data, methods and perspective as presented in Chiou (2008) to report lower potential benefits from international diversification for U.S. investors during the previously reported 1988–2004 investment period. The extended results for 1988–2014 are also presented. Naive international diversification is not found to provide positive return-to-risk (RR) gains or volatility reducing benefits versus the U.S. market. Portfolios optimized with no short sales and weakened weight constraints on positive market allocations can provide RR gains and volatility reducing benefits. The positive RR benefits from diversification out of the U.S. market portfolio are not found to be statistically significant for both periods measured.     

Itchy feet vs cool heads: Flow of funds in an agent-based financial market

Investors tend to move funds when they are unhappy with their current portfolio managers׳ performance. We study the effect of the size of this flow of funds in an agent-based model of the financial market. The model combines the discrete choice approach from agent-based modelling, where all capital is mobile, with the evolutionary finance framework where all growth is endogenous. Our results show that, if investors exhibit recency bias in evaluating portfolio managers׳ performance, even a small amount of freely flowing capital has a huge impact on the market dynamics and the survival of noise traders. We also find that investors׳ intensity of choice is a driving force for excess volatility and extreme price movements when the size of the flow of funds is large.     

The economic benefits of market timing the style allocation of characteristic-based portfolios

Many exchange traded funds track simple characteristic-based equity portfolios such as the market capitalization, the fundamental value or the inverse volatility portfolio. This paper provides theoretical and empirical evidence for the economic benefits in exploiting the timing-gains that result from the time-varying relative performance of these characteristic-based portfolios. Under a factor model for expected returns, we show that this dynamic portfolio allocation can be efficient across the low-dimensional set of characteristic-based portfolios. We assess the out-of-sample performance on the S&P 100 universe over the period 1990–2013 and show gains in stability and significant positive risk-adjusted returns for the dynamic style portfolio. We conduct several robustness tests and extensions confirming the benefits of dynamic style allocation across characteristic-based portfolios.     

Scheduled macroeconomic news announcements and intraday market sentiment

We analyze the effects of scheduled macroeconomic news on intraday and daily market sentiment by comparing sentiment on news announcement dates with that on non-announcement dates. Announcements of macroeconomic indicators change neither intraday nor daily market sentiment. However, the directions of the announced values have asymmetric effects on intraday market sentiment, although they do not affect daily market sentiment. For example, an announcement of an increase in the gross domestic product (GDP) reduces short-term intraday market sentiment, whereas an announcement of a decrease in GDP does not significantly affect intraday market sentiment. We also find that the effect of intraday market sentiment on short-term market returns is greater following announcements of macroeconomic indicators that significantly affect intraday market sentiment.     

Islamic equity market integration and volatility spillover between emerging and US stock markets

The purpose of this paper is to study the conditional correlations across the US market and a sample of five Islamic emerging markets, namely Turkey, Indonesia, Pakistan, Qatar, and Malaysia. The empirical design uses MSCI (Morgan Stanley Capital International) Islamic equity index since it applies stringent restrictions to include companies. Indeed, two main restrictions must be met: (i) the business activity must be compliant with Shari’ah (i.e., Islamic law) guidelines and (ii) interest-bearing investments and leverage ratios should not exceed upper limits. Three models are used: multivariate GARCH BEKK, CCC, and DCC. The estimation results of the three models show that the US and Islamic emerging equity markets are weakly correlated over time. No sheer evidence supports that the US market spills over into the Islamic emerging equity markets. Besides interpreting the results in terms of weak market integration, the peculiar specificities of the Islamic finance industry and the admittance conditions to the MSCI Islamic equity index contribute to explaining them. Indeed, Islamic finance bans interest-bearing investments and imposes some rules, such as asset-backing, which has sizeable impacts on volatility spillover and shocks transmissions, alongside with the close linkage between real and financial sectors. These findings suggest that investors should take caution when investing in the Islamic emerging equity markets and diversifying their portfolios in order to minimize risk.     

Do cryptocurrencies provide better hedging? Evidence from major equity markets during COVID-19 pandemic

Using the five-minute interval price data of two cryptocurrencies and eight stock market indices, we examine the risk spillover and hedging effectiveness between these two assets. Our approach provides a comparative assessment encompassing the pre-COVID-19 and COVID-19 sample periods. We employ copula models to assess the dependence and risk spillover from Bitcoin and Ethereum to stock market returns during both the pre-COVID-19 and COVID-19 periods. Notably, the COVID-19 pandemic has increased the risk spillover from Bitcoin and Ethereum to stock market returns. The findings vis-à-vis portfolio weights and hedge effectiveness highlight hedging gains; however, optimal investments in Bitcoin and Ethereum have reduced during the COVID-19 pandemic, while the cost of hedging has increased during this period. The findings also confirm that cryptocurrencies cannot provide incremental gains by hedging stock market risk during the COVID-19 pandemic.     

The structure of dynamic correlations in multivariate stochastic volatility models

This paper proposes two types of stochastic correlation structures for Multivariate Stochastic Volatility (MSV) models, namely the constant correlation (CC) MSV and dynamic correlation (DC) MSV models, from which the stochastic covariance structures can easily be obtained. Both structures can be used for purposes of determining optimal portfolio and risk management strategies through the use of correlation matrices, and for calculating Value-at-Risk (VaR) forecasts and optimal capital charges under the Basel Accord through the use of covariance matrices. A technique is developed to estimate the DC MSV model using the Markov Chain Monte Carlo (MCMC) procedure, and simulated data show that the estimation method works well. Various multivariate conditional volatility and MSV models are compared via simulation, including an evaluation of alternative VaR estimators. The DC MSV model is also estimated using three sets of empirical data, namely Nikkei 225 Index, Hang Seng Index and Straits Times Index returns, and significant dynamic correlations are found. The Dynamic Conditional Correlation (DCC) model is also estimated, and is found to be far less sensitive to the covariation in the shocks to the indexes. The correlation process for the DCC model also appears to have a unit root, and hence constant conditional correlations in the long run. In contrast, the estimates arising from the DC MSV model indicate that the dynamic correlation process is stationary.     

Corporate tax,financial leverage,and portfolio risk

We examine the theoretical implications of corporate income tax for a risky portfolio in a aggregate-endowment economy. In this model, corporate income tax affects the portfolio risk associated with the rebalancing motive during market clearance. An asset is defined as a portfolio of stocks and bonds whose portfolio weights are similar to financial leverage. Corporate tax can decrease after-tax consumption from dividends (increase leverage) and increase the tax shield that increases dividends (decrease leverage). Changes in dividends are responsible for the correlation between expected dividend growth and consumption growth and, thus, affect stock pricing and returns. Overall, the model is characterized by tax-induced portfolio risk associated with financial leverage.     

Structural breaks in the correlations between Asian and US stock markets

The study explores the structural breaks in the correlations between nine Asian stock markets and the US stock market. This study employs the EGARCH-DCC model to obtain the daily correlations between Asian and the US stock markets, and use the method of Carrion-i-Silvestre (2005) to detect the structural breaks. The empirical results indicate there are multiple breaks in the correlations and imply that both 2001 Dot-com bubble and 2008 financial crisis have impacts on the correlations between Asian and the US markets. These results bring the crucial insights for the portfolio strategy of international investors.     

Risk spillover from crude oil prices to GCC stock market returns: New evidence during the COVID-19 outbreak

In this study, we examine oil price extreme tail risk spillover to individual Gulf Cooperation Council (GCC) stock markets and quantify this spillover’s shift before and during the COVID-19 pandemic. A dynamic conditional correlation generalized autoregressive heteroscedastic (DCC- GARCH) model is employed to estimate three important measures of tail dependence risk: conditional value at risk (CoVaR), delta CoVaR (ΔCoVaR), and marginal expected shortfall (MES). Using daily data from January 2017 until May 2020, results point to significant systemic oil risk spillover in all GCC stock markets. In particular, the effect of oil price systemic risk on GCC stock market returns was significantly larger during COVID-19 than before the pandemic. Upon splitting COVID-19 into two phases based on severity, we identify Saudi Arabia as the only GCC market to have experienced significantly higher exposure to oil risk in Phase 1. Although all GCC stock markets received greater oil systemic risk spillover in Phase 2 of COVID-19, Saudi Arabia and the United Arab Emirates appeared more vulnerable to oil extreme risk than other countries. Our empirical findings reveal that investors should carefully consider the extreme oil risk effects on GCC stock markets when designing optimal portfolio strategies, minimizing portfolio risk, and adopting dynamic diversification process. Policymakers and regulators should also enact awareness, oversight, and action plans to minimize adverse oil risk effects.     

Factor analysis of the Big Five Questionnaire using polychoric correlations in children

Although the Big Five Questionnaire for children (BFQ-C) (C. Barbaranelli et al., Manuale del BFQ-C. Big Five Questionnaire Children, O.S. Organizazioni, Firenze, 1998) is an ordinal scale, its dimensionality has often been studied using factor analysis with Pearson correlations. In contrast, the present study takes this ordinal metric into account and examines the dimensionality of the scale using factor analysis based on a matrix of polychoric correlations. The sample comprised 852 subjects (40.90% boys and 59.10% girls). As in previous studies the results obtained through exploratory factor analysis revealed a five-factor structure (extraversion, agreeableness, conscientiousness, emotional instability and openness). However, the results of the confirmatory factor analysis were consistent with both a four and five-factor structure, the former showing a slightly better fit and adequate theoretical interpretation. These data confirm the need for further research as to whether the factor ‘Openness’ should be maintained as an independent factor (five-factor model), or whether it would be best to omit it and distribute its items among the factors ‘Extraversion’ and ‘Conscientiousness’ (four-factor model).     

Predictability in international stock returns using currency fluctuations and forward rate forecasts

We find that currency risk, specifically dollar exchange rate risk, is a determinant in firm stock returns worldwide. Firms exposed to various dollar exchange rate risks worldwide exhibit strong differences in expected returns, and firms with previously high sensitivity to their home country’s exchange rate fluctuation subsequently outperform during the following six to twelve months. This effect is robust across countries, time, exchange rate policies, and macroeconomic environments. We find that information in currency forward rates provides additional, useful information when predicting future returns of these currency-sensitive firms, and dynamic, state-space estimation of currency forward rate term structures complements the predictability.     

Misvaluation comovement,market efficiency and the cross-section of stock returns: Evidence from China

In this study, we examine the relation between stock misvaluation and expected returns in China's A-share market. We measure individual stocks’ misvaluation based on their pricing deviation from fundamental values, following Rhodes-Kropf et al. (2005. J. Finan. Econ. 77 (3), 561) and Chang et al. (2013. J. Bank. Finance, forthcoming), and find that the measure has strong and robust return predictive power in the Chinese market. We further form a misvaluation factor and find that misvaluation comovement and systematic misvaluation exist in the Chinese market. A comparison of our results with those of Chang et al. (2013. J. Bank. Finance, forthcoming) reveals that the misvaluation effect is much stronger in the Chinese market than in the U.S market. This evidence is consistent with the notion that the Chinese market is much less efficient than the U.S. market. Finally, we show that the return predictive power of misvaluation has weakened since China launched its split-share structure reform in 2005, which could result from the fact that the reform helps to promote market efficiency.     

Spillovers and diversification potential of bank equity returns from developed and emerging America

We examine the network spillovers, portfolio allocation characteristics and diversification potential of bank returns from developed and emerging America. We draw our results by applying a directional spillover index, the tail-event driven network (TENET) and nonlinear portfolio optimization methods on bank returns. We find that the spillovers and connectedness among banks from emerging America are noticeably smaller than those among banks from developed America. The largest emerging market spillover transmitters and receivers are the banks from Brazil, followed by the banks from Chile. The largest developed market spillover transmitter is JP Morgan Chase. The connectedness among banks from developed America is dominated by the banks from the USA, relative to those from Canada. The total connectedness of the emerging market banks is more intensified than that of the banks from developed America due to the effect of the COVID-19 pandemic. The portfolio optimization shows that in developed America, the largest banks from the USA are the largest risk contributors to total portfolio risk, whereas the banks from Canada contribute the least risk. In emerging America, the banks from Brazil contribute the most risk to total portfolio risk while the banks from Peru and one bank from Colombia contribute the least risk. The portfolio of banks from emerging America offers greater diversification potential and lower total portfolio allocation risk.     

On economic uncertainty,stock market predictability and nonlinear spillover effects

This paper uses a k-th order nonparametric Granger causality test to analyze whether firm-level, economic policy and macroeconomic uncertainty indicators predict movements in real stock returns and their volatility. Linear Granger causality tests show that whilst economic policy and macroeconomic uncertainty indices can predict stock returns, firm-level uncertainty measures possess no predictability. However, given the existence of structural breaks and inherent nonlinearities in the series, we employ a nonparametric causality methodology, as linear modeling leads to misspecifications thus the results cannot be considered reliable. The nonparametric test reveals that in fact no predictability can be observed for the various measures of uncertainty i.e., firm-level, macroeconomic and economic policy uncertainty, vis-à-vis real stock returns. In turn, a profound causal predictability is demonstrated for the volatility series, with the exception of firm-level uncertainty. Overall our results not only emphasize the role of economic and firm-level uncertainty measures in predicting the volatility of stock returns, but also presage against using linear models which are likely to suffer from misspecification in the presence of parameter instability and nonlinear spillover effects.     

International business cycles and risk sharing with uncertainty shocks and recursive preferences

This paper analyzes the effects of output volatility shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country, two-good world with consumption home bias, recursive preferences, and complete financial markets. When the risk aversion coefficient exceeds the inverse of the intertemporal substitution elasticity, then an exogenous rise in a country׳s output volatility triggers a wealth transfer to that country, to compensate for the greater riskiness of the country׳s output stream. This risk sharing transfer raises the country׳s consumption, lowers its trade balance and appreciates its real exchange rate. In the recursive preferences framework here, volatility shocks account for a non-negligible share of the fluctuations of net exports, net foreign assets and the real exchange rate. These shocks help to explain the high empirical volatility of the real exchange rate and the disconnect between relative consumption and the real exchange rate.     

Market integration between conventional and Islamic stock prices

The paper assesses the market integration between conventional and Islamic stock prices from the long- and short-run perspectives for France, Indonesia, the UK and the US from September 8, 2008 to September 6, 2013 using various econometric approaches. The results show long-run relationships for all countries, except for the UK where there is no cointegration between conventional and Islamic stock prices. These findings suggest that the Islamic finance industry in the considered economies (except the UK) does not seem to be compliant to Islamic law's maxims, which hinders portfolio managers and market participants to benefit from the opportunities of international diversification and hedging effectiveness. From the correlation perspective, there is evidence of weak linkages between the Indonesian market and the developed markets for both conventional and Islamic stock prices, thus suggesting that investors can diversify their portfolios at the international level to minimize risk. However, there is high connection between the developed markets for both conventional and Islamic indexes. In addition, for each economy, the Islamic index is found to be strongly linked with its conventional counterpart. The structural change analysis reveals common break dates for several cross correlations, thus reflecting the similar time-paths of the interactions between markets. The presence of breaks in the inter-market linkages has important implications for international investors as regards portfolio diversification benefits and for financial policy makers regarding contagion risks and market policies.     

Monetary policy in open economies: Practical perspectives for pragmatic central bankers

This paper reviews and interprets some of the key policy implications that flow from a class of DSGE models for optimal monetary policy in the open economy. The framework suggests that good macroeconomic outcomes in open economies are possible by focusing inflation targeting that is implemented by a Taylor type rule, a rule that in equilibrium is reflected in the exchange rate as an asset price. Optimal monetary policy will not be able deliver a stationary (‘stable’) nominal exchange rate – let alone a fixed exchange rate or one that remains inside a target zone – because, absent a commitment device, optimal monetary can’t deliver a stationary domestic price level. Another feature in the data for inflation targeting countries that is consistent with monetary policy via Taylor type rule is that it will tend push the nominal exchange rate in the opposite direction from PPP in response to an ‘inflation’ shock—the ‘bad news god news’ result of Clarida and Waldman (2008. Is Bad News about Inflation Good News for the Exchange Rate. In: John Campbell, (Ed.), Asset Prices and Monetary Policy, Chicago: University of Chicago Press), Clarida and Waldman (2014. Bad News About Inflation is Good News for the Nominal Exchange Rate Under Optimal Monetary Policy: DSGE Theory and a Decade of Empirical Evidence). This is so even though in the long run of these models the nominal exchange rate must in expectation obey PPP.     

An analysis of the capital asset pricing model in the Egyptian stock market

This paper offers evidence confirming the validity of applying modern portfolio theory and capital asset pricing models to the emerging stock market of Egypt. The results indicate that market risk, as measured by beta and preference for skewness, seems to play a significant role in the returns dynamics in the Egyptian stock market. There is a significant and positive premium for companies with positive skewness. With regard to the return-risk trade off, the results indicate that a portfolio that was based on consumer staples and financial companies (mainly banks) with low betas had outperformed a portfolio containing construction, materials, hotels, and weaving companies with larger betas. Historically, the government's nationalizations that took place, between the mid fifties to the mid sixties, had adversely affected companies in the industrial and construction sectors more than consumer staples companies and banks. This could explain why lower beta companies were observed more in consumer staples, banks, and pharmaceuticals.