A Markov Regime Switching Approach towards Assessing Resilience of Romanian Collective Investment Undertakings

Daniel Armeanu,Iulian Panait,Leonardo Badea,Ştefan Gherghina

doi:10.3390/su11051325

Abstract

This paper explores the sensitivity of Romanian collective investment undertakings’ returns to changes in equity, fixed income and foreign exchange market returns. We use a sample of 80 open-end investment funds and pension funds with daily returns between 2016 and 2018. Our methodology consists of measuring changes in the daily conditional volatility for the fund returns (EGARCH) and changes in their conditional correlation with selected market risk factors (DCC MV-GARCH) throughout different volatility regimes identified using a Markov Regime Switching model. We argue that, on average, the level of conditional correlations between funds and market risk factors remained stable and unconcerned by the volatility regimes. In addition, for only less than half of the funds in the sample, their volatility regimes were synchronized with those of the selected market risk factors. We found that, on average, fund returns are more correlated with equity returns and less correlated with changes in local bond yields, while not being significantly influenced by changes in foreign bond yields or changes in foreign exchange. During the period investigated equity returns were the most volatile while the funds returns volatility were, on average, much more reduced. Overall, our results show the resilience of the Romanian collective investment sector to the selected market risk factors, during the investigated period.

Highlights

Institutional investors represent one of the most important components of the capital market and play an important role in the financial system
We observe that the equity risk factors are the ones that most often trigger similar volatility regimes for the funds’ returns, while in the case of the other three risk factors the reaction is much weaker in the sample of funds that we used in this research
This prompts us to formulate a preliminary conclusion that the Romanian investment and pension fund sectors are more sensitive to the high volatility regimes of the equity markets in comparison with the bond markets and the FX market

Summary

Introduction

Institutional investors represent one of the most important components of the capital market and play an important role in the financial system. According to the monthly reports of the Romanian Financial Supervisory Authority [1], pension funds are the largest non-bank sub-sector of the local financial system, with assets of 10.6 billion EUR (5.2% of GDP) at the end of 2018. There are 17 pension funds (split between two pillars: mandatory and optional) which invest mainly in fixed income (83%) and listed equity (17%). These funds hold approximately 20% of the outstanding sovereign bonds issued by the Romanian Government and around 20% of the capitalization of the free float on the national stock exchange, while accounting for 15% of the exchange turnover. There are several types of open-end funds (e.g., 19 equity funds, 25 bond funds, 33 hybrid funds and 1 money market fund) with the largest category in terms of assets being the bond funds (3.4 billion EUR)

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