Broader Equity Market Research Articles

Trading Activity in Public Real Estate Markets

Trading activity is an important characteristic of financial markets, since it is related to price discovery, volatility, and market liquidity. It is therefore of crucial importance to understand what drives trading activity in real estate markets. Here, we use a panel dataset consisting of 142 US REIT stocks observed over almost 20 years and a fixed-effects regression approach to link variation in trading activity to proxies for different trading motives (theory-motivated). The paper shows that the drivers of trading activity in real estate markets are distinct from those in the broader equity market. Proxies for portfolio rebalancing needs and liquidity trading are shown to be important trading motives in REIT markets. However, unlike in the broader equity market, difference of opinions and information-based trading motives seem to play a minor role for REIT trading activity.

Forecasting high‐yield equity and CDS index returns: Does observed cross‐market informational flow have predictive power?

AbstractWe examine the predictive power of cross‐market informational flow in the systematic high‐yield credit default swap (CDS) and equity markets from 2004 to 2019. Overall, we find both markets useful in forecasting future values of the other, indicating each is more efficient in pricing certain types of information. However, the CDS market has an informational advantage over the high‐yield and broader equity market, something not previously documented in the closely related literature, although the advantage and forecasting ability of these markets have decreased with time due to lower volatility. These results have implications for high‐yield investors and stakeholders who monitor Markit's CDX North American High‐Yield Index for informational content.

Whose Disagreement Matters? Household Belief Dispersion and Stock Trading Volume

Abstract Theoretical models have long recognized the role of investor disagreements in the marketplace, but little evidence is documented regarding how belief dispersion affects trading activities in the broad equity market. Using over three decades of data from a survey of US households, we introduced a novel measure of household macroeconomic belief dispersion and document its positive relationship with market-wide stock trading volume, even after controlling for an array of professional analysts’ belief dispersion. Results are more pronounced for the belief dispersion among households who are more likely to own stocks. Furthermore, we show that the household belief dispersion is priced in the cross-section of stock returns, whereas that among professional analysts is not.

Diamonds and precious metals for reduction of portfolio tail risk

ABSTRACT We study the performance of diamonds compared to gold and other precious metals in mitigating the tail risk of a diversified equity market portfolio over the period June 2007 to October 2018. Our results display a diversification benefit of some diamond indices, which also improve the portfolio reward-to-risk ratio. To corroborate this evidence, we study the dependence structure and tail dependence of diamonds and a broad equity market portfolio and compare it to the dependence obtained with gold and other precious metals. Results from fitting a bivariate copula show that the average left tail dependence reaches its minimum when diamonds are used. We also show that using shares of diamond-mining companies does not provide the same benefits.

Using the Volatility Risk Premium to Mitigate the Next Financial Crisis

Ten years have passed since the trough of the Global Financial Crisis, and the US equity market has experienced one of the longest stretches of ascent in history. Some investors have started questioning whether the US stock market is overvalued and if a recession is on the way. It is usually impossible to predict the next financial crisis. An investor’s best course of action may be to adjust the investment portfolio to be resilient against potential market headwinds. This article argues for utilizing the volatility risk premium (VRP), specifically option-selling VRP strategies, to mitigate the losses the portfolio may suffer from a future financial crisis. Such a VRP strategy, if implemented with out-of-the-money equity index options, can help investors cushion the losses from an equity market crash and recover more quickly than the broad equity market. Investors can utilize the VRP by itself or combine it with traditional equity to construct the most suitable investment strategies. This article further examines implementation choices of such strategies and stress tests their performance with four representative crises from the past three decades. <b>TOPICS:</b>Analysis of individual factors/risk premia, financial crises and financial market history, performance measurement <b>Key Findings</b> • The US equity market may be overvalued after the decade-old rally, and an investor’s best approach may be portfolio adjustment against potential market headwinds. • The volatility risk premium (VRP), specifically option-selling VRP strategies, can help investors mitigate losses the portfolio may suffer from a future financial crisis. • Two mechanisms help overlay VRP strategies: low delta options only initiate payouts after the index fall below strike prices; higher implied volatility (IV) translates into higher premium collection in crisis times.

Spillovers between the oil sector and the S&P500: The impact of information flow about crude oil

Crude oil is one of the most important commodities in the real economy and as such the relationship between oil prices and broader equity markets has attracted a lot of research attention. Recent work has considered directional spillovers or links between oil and equity markets. In recent times there has been a growing body of research into the impacts of news and media attention on asset returns, both in the context of and in particular with both the oil and equity markets but also within each of these. This paper considers how news or information flows about crude oil influence the spillover links between these assets. Using realized volatility estimates based on high frequency data, the empirical analysis reveals a number of novel results in terms of the behavior of these linkages. Increased news flow about oil reduces the impact of the broader equity market on the oil sector, implying that it is driven more by oil specific shocks and less by more general financial market conditions. It also increases the impact of the oil sector on the broader equity market. These results have potential implications for hedging and portfolio allocation.

Do Listed Clean Energy Infrastructure Shares Make Financial Sense for Investors?

Despite supportive government policies and rapid technological improvements, the participation of institutional investors in the clean energy sector remains relatively limited. One of the key challenges to increase capital flows to clean energy projects is a robust historical record of risk and financial return. Our paper helps to fill this knowledge gap by documenting the past financial performance of “Yieldcos,” publicly-listed equity vehicles holding multiple operational renewable energy projects. We document risk-adjusted returns for Yieldcos in North America and the United Kingdom. Over the period studied, a portfolio of UK Yieldcos generated risk-adjusted returns superior to the broad equity market and a range of sectoral indices. On the contrary, US Yieldco portfolio is characterized by high volatility and relatively poor financial returns. We provide evidence of diversification benefits from the UK Yieldco portfolio, indicating the potential for sustainable energy infrastructure to be characterized as a unique asset class whose risk/return characteristics cannot be replicated from within a diversified investment portfolio.

Equity Solvency Capital Requirements - What Institutional Regulation Can Learn from Private Investor Regulation

Solvency II has one standard equity solvency capital requirement for type 1 or developed market stocks (39 percent) and one for type 2 or emerging market stocks (49 percent). As such, differences in financial economic risk of stock portfolios within developed or emerging markets do not influence solvency requirements. This encourages risk-seeking behavior by insurance companies, and could sustain or even create structural mispricing in the cross-section of stock returns. We argue to improve Solvency II regulation by aligning it with more sophisticated European regulation that is already in place for mutual funds. Specifically, we propose to multiply the standard solvency charge of 39 percent with the ratio of equity portfolio volatility to broad equity market volatility. This ratio will be above one for more risky portfolios and below one for less risky portfolios, meaning that high-risk stock portfolios require more solvency capital than the market, while low-risk stock portfolios require less. Our approach encompasses the existing distinction between emerging and developed markets, and reduces geography to just one of many potential sources of risk that should be recognized. The proposed approach gives better incentives to institutional investors, contributes to market efficiency, and is much less prone to regulatory arbitrage than the existing approach.

Equity Solvency Capital Requirements: What Institutional Regulation Can Learn from Private Investor Regulation

Solvency II has one standard equity solvency capital requirement for type 1 or developed market stocks (39 percent) and one for type 2 or emerging market stocks (49 percent). As such, differences in financial economic risk of stock portfolios within developed or emerging markets do not influence solvency requirements. This encourages risk-seeking behavior by insurance companies, and could sustain or even create structural mispricing in the cross-section of stock returns. We argue to improve Solvency II regulation by aligning it with more sophisticated European regulation that is already in place for mutual funds. Specifically, we propose to multiply the standard solvency charge of 39 percent with the ratio of equity portfolio volatility to broad equity market volatility. This ratio will be above one for more risky portfolios and below one for less risky portfolios, meaning that high-risk stock portfolios require more solvency capital than the market, while low-risk stock portfolios require less. Our approach encompasses the existing distinction between emerging and developed markets, and reduces geography to just one of many potential sources of risk that should be recognized. The proposed approach gives better incentives to institutional investors, contributes to market efficiency, and is much less prone to regulatory arbitrage than the existing approach.

An Analysis of Returns of Moderately Aged Buyout Funds with Low Residual Values

In this article, the authors conduct a study dedicated principally to moderately aged leveraged buyout funds that have had the opportunity for multiple portfolio company liquidations, or have been fully liquidated. Examining 186 funds in the vintage years from 2000 to 2007 with complete cash flow data from the Preqin database, they find that 61% of funds beat the S&P 500 Index plus 3% (a common benchmark), and 39% did not. Funds originated during the boom years (2005 to 2007) are less successful, with 41% beating the benchmark to date, and 59% falling short. Thus, they find that funds from the earlier vintage years have better performance, relative to broad equity market benchmarks, than those from later years. The later vintage year funds have larger RVPIs than the early vintage year funds, most of which had been fully liquidated. In addition, the authors find that larger funds tend to perform better than small funds, and moderately-liquidated funds tend to have worse results than mostly-liquidated funds. Lastly, in examining a group of fund families with three or more funds, they find no strong evidence of consistency.

An Attempt to Analyze Older Buyout Funds (Vintage Years 2000-2007), So As to Diminish the Impact of General Partners (GPs) Setting Residual Values in Rate of Return Calculations

We conduct a study dedicated principally to older leveraged buyout funds that have had the opportunity for multiple portfolio company liquidations, or have been fully liquidated. Examining 186 funds in the vintage years from 2000 to 2007 with complete cash flow data from the Preqin database, we find that 61% beat the S&P 500 plus 3% ( a common benchmark), and 39% did not. Funds originated during the boom years (2005 to 2007) are less successful, with 41 % beating the benchmark to date, and 59% falling short. Thus, we find that funds from the earlier vintage years have better performance relative to broad equity market benchmarks than the later years. The later vintage year funds have larger RVPIs than the early vintage year funds, most of which had been fully liquidated. In addition, we find that moderately-liquidated funds tend to have worse results than mostly-liquidated funds. Lastly, in examining a group of fund families with three or more funds, we find no strong evidence of consistency.

Oil Price Volatility And Sectoral Returns Uncertainties: Evidence From A Threshold Based Approach For The Australian Equity Market

This paper examines the existence of a non-linear relationship between oil price volatility and equity market uncertainty. The study specifically analyses the pattern of effects of oil price volatility on the broader equity market as well as the sectoral equity returns volatility within Australian Economy. We use a logistic transition based autoregressive model (LSTR) developed by Terasvirta and Anderson (1992) and Terasvirta, (1994). We find that the hypothesis of linearity between oil price volatility and equity market uncertainty is rejected for six out of 10 sectors of the Australian economy. The retention of LSTR model suggests that the oil return volatility has high and low regimes that affect equity markets differently across the sectors. The transition functions suggest that switching of oil price volatility from low to high regime is abrupt for consumer discretion, financial and material sectors while such transition is smooth for consumer staple, energy, and industrial sectors. The results also show that some sectors are quicker in responding to heightened volatility. From the VAR framework, the impulse response functions show that a one period increase or a shock in oil price volatility raises volatility of equity in consumer discretion, consumer staple, finance, industry, telecom and consumer staple sectors. Of these, equity volatility in industries and financial sectors seem to exhibit a prolonged positive response following the oil price volatility shock. Also, equity volatility of industries seems to rise by much larger proportion compared to the equity volatility response of other sectors. These findings are helpful as a guide for sectoral rotation strategies. In view of the increased volatility of oil prices due to a negative impact of oil price shock and the resultant surge of uncertainty, Australian firms could formulate their short and long run investment plans based on volatility threshold level. Firms in consumer discretion, financial and industrial sector could consider postponement of investment if the volatility in oil price exceeds certain threshold. Also, firms in the consumer staple, energy and materials industry need to make prudent business decisions in situations where oil price volatility falls within the threshold range as identified by the LSTR2 models. Based on the findings, there is a need for public policy formulation to reduce the adverse impacts of increased oil price uncertainties on the Australian economy during periods of unforeseen random events including depressions and crises.

Country ETF returns and volatility spillovers in emerging stock markets, Europe and USA

Purpose – The purpose of this paper is to investigate the linkages among equity exchange traded funds (ETF) returns and transmission of volatilities of the USA, Europe and key emerging countries’ stock markets. Standard &amp; Poor’s 500 (spy) and iShares Europe are used to represent the USA and European stock markets, the emerging market part of the data set consists of daily returns of equity ETF representing broad equity market indices of the BRIC countries (Brazil, Russia, India and China); the mist countries (Mexico, Indonesia, South Korea and Turkey) and South Africa and covers the period of February 3, 2012-February 28, 2014. Design/methodology/approach – The paper utilizes multi-variate auto-regressive moving-averages (MARMA) methodology to study equity market returns and spillovers. Second, generalized auto-regressive conditional heteroskadasticity (GARCH) modeling is employed to model volatility persistence and transmissions. Findings – The findings include the existence of significant co-movement of returns among all country ETFs; however, despite increasing interdependencies among the global stock markets there are still very good opportunities for diversification. For example, USA and Europe based investors may do well to ignore opportunities in each other’s markets but can realize diversification benefits by investing in ETFs representing China, South Africa and Turkey. As far as volatilities are concerned, the findings indicate that no ETF volatility is transmitted from the sample countries to USA, Brazil, China and South African stock markets. Also, US market volatility is transmitted to India, Russia, Mexico and Turkey while European volatility spills over to Mexico and South Korea. The presence of spillovers among stock markets’ return series and persistence of volatilities are useful to investors interested in diversifying their portfolios and to traders/fund managers who are interested in maximizing returns. Research limitations/implications – The implications include: first, investors should not only rely on current domestic news to guide their investment decisions, but also take into consideration international news for there are substantial spillovers. Second, given that volatilities can proxy for risk, there are lessons for both individual and institutional investors in terms of further examining pricing securities, hedging and other trading strategies as well as framing regulatory policies. Third, investors should be able to ride the financial cycle by following closely monetary policies of the FED and European Central Bank and resulting credit expansion or contraction since research indicates (and as corroborated in this study) equity prices are linked to VIX which is also correlated with capital flows and credit expansion and interest rates. Limitations include: first, the investigation could be expanded to include individual countries in Europe instead of using one Europe-wide ETF. As ETFs for other emerging markets become available it is also possible to include additional countries. Second, ETFs may not be the best vehicles for diversification. Originality/value – Methodology (MARMA and GARCH) is widely used for analyzing financial data. The use of BRIC and MIST countries and the interaction among them may be novel. Spillovers among emerging financial markets is a fairly new area. Typically, the authors see studies of spillovers from the developed countries to the developing ones. The data period is important since it covers both credit expansion and contraction (or the start of it) by the FED and is current.

Reactions of equity markets to recent financial reforms

We conduct event studies of broad equity market reaction to the events surrounding introduction and enactment of recent financial reform initiatives. In response to the introduction of the Dodd-Frank Act, financial firms and firms from a few other industries experience a statistically significant decrease in systematic risk, while a substantial number of industries, representing a broad cross-section of the economy, experiences a statistically significant increase in systematic risk. The systematic risk in some industries does not change. The increase in risk is concentrated in industries in which firms are dependent on external capital. The initial market reaction to Dodd-Frank indicates that it may lower the risk in financial firms, but the risk for many non-financial firms simultaneously increases.

The Performance of Mostly Liquidated Buyout Funds, 2000-2007 Vintage Years

We conduct a study dedicated principally to older leveraged buyout funds that have had the opportunity for multiple portfolio company liquidations, or have been fully liquidated. Examining 186 funds in the vintage years from 2000 to 2007 with complete cash flow data from the Preqin database, we find that 61% beat the S&P 500 plus 3% (a common benchmark), and 39% did not. We find that funds from the earlier vintage years had better performance relative to broad equity market benchmarks than the later years. The later vintage year funds have larger RVPIs than the early vintage year funds, most of which had been fully liquidated. In addition, we find that moderately-liquidated funds tend to have worse results than mostly-liquidated funds. Lastly, in examining a group of fund families with three or more funds, we find no strong evidence of consistency.

Risk Parity Portfolio: An Alternative for the Spanish Stock Market

Capitalization-weighted indexes are the most common way to gain access to broad equity market performance. However, interest in risk based investing has grown steadily in the recent post-crisis years as investors seek to overcome the limitations of traditional approaches to asset allocation. Despite the interest, there remains confusion about how to implement these strategies in any investor’s portfolio, and even more when we want to implement it into a particular asset class. This paper compares some risk-based indexation methodologies, where risk parity takes an important role, and illustrates these issues as it applies to the Ibex 35 universe. We also use the typical capitalization-weighted index as a benchmark. Using 10 years of data, we show that risk parity portfolios outperform all the underlying portfolios on an absolute and risk adjusted basis.

Determinants and information of REIT pricing

Utilizing advanced asset pricing techniques, we investigate the long-term relation between the general economy, the broad equity market and Real Estate Investment Trusts (REITs). Both monetary and real economy factors, along with the stock market factor, are found to be determinants in REIT pricing. On a quarterly basis, we provide evidence that the REIT market is efficient in terms of incorporating information from the economy and the stock market. Furthermore, we test and find that REITs provide significant forward-looking information regarding the economy.

An Empirical Investigation of Consumption-Based Asset Pricing Models With Stochastic Habit Formation

We econometrically estimate a consumption-based asset pricing model with stochastic internal habit and test it using the generalized method of moments. The model departs from existing models with deterministic internal habit (e.g., Dunn and Singleton (1983), Ferson and Constan- tinides (1991), and Heaton (1995)) by introducing shocks to the coefficients in the distributed lag specification of consumption habit and consequently an additional shock to the marginal rate of substitution. The stochastic shocks to the consumption habit are persistent and provide an additional source of time variation in expected returns. Using Treasury bond returns and broad equity market index returns, we show that stochastic internal habit formation models resolve the dichotomy between the autocorrelation properties of the stochastic discount factor and those of expected returns. Consequently, they provide a better explanation of time-variation in expected returns than models with either deterministic habit or stochastic external habit.

An Empirical Investigation of Consumption-Based Asset Pricing Models with Stochastic Habit Formation

We econometrically estimate a consumption-based asset pricing model with stochastic internal habit and test it using the generalized method of moments. The model departs from existing models with deterministic internal habit (e.g., Dunn and Singleton (1983), Ferson and Constantinides (1991), and Heaton (1995)) by introducing shocks to the coefficients in the distributed lag specification of consumption habit and consequently an additional shock to the marginal rate of substitution. The stochastic shocks to the consumption habit are persistent and provide an additional source of time variation in expected returns. Using Treasury bond returns and broad equity market index returns, we show that stochastic internal habit formation models resolve the dichotomy between the autocorrelation properties of the stochastic discount factor and those of expected returns. Consequently, they provide a better explanation of time-variation in expected returns than models with either deterministic habit or stochastic external habit.

Monetary policy transmission and real estate investment trusts

This paper assesses the response of real estate investment trusts (REIT's) to unexpected changes in US monetary policy. A critical element in this study is the use of futures markets to isolate unexpected changes in the policy rate. We find a significant negative response of REIT returns to a surprise change in the policy rate. The paper then examines the potential sources behind such an observed response. We find important differences between the REIT market and the broader equity market. Adopting a variance decomposition approach we find that monetary policy surprises consistently have an impact on REIT returns and that the dividend channel is a driving force behind this influence. The results indicate the particular sensitivity of the general real estate market to Central Bank behaviour. Copyright © 2010 John Wiley & Sons, Ltd.