Canadian Equity Research Articles

The low-magnitude and high-magnitude asymmetries in tail dependence structures in international equity markets and the role of bilateral exchange rate

This paper introduces a new Markov-switching mixture copula model with a GAS mechanism in the weighting process to investigate the structures of the upper-tail dependence and lower-tail dependence in a low-magnitude asymmetry state and a high-magnitude asymmetry state for international equity markets. Three important findings arise. First, there are obvious low-magnitude and high-magnitude asymmetries in the tail dependence between equity markets of the U.S. and four nations (Canada, France, Germany, and the U.K.). Second, the difference between the upper-tail dependence and lower-tail dependence increases substantially around after 2000. In general, the importance of the lower-tail dependence is stronger than that of the upper-tail dependence in the high-magnitude asymmetry state. However, the Brexit panic does not change the importance of the tail dependence for the U.S. and European equity markets. Third, the evidence for the impact of the bilateral exchange rate on the tail dependence appears only for some international equity markets during the period of a high-magnitude asymmetry state. The bilateral exchange rate has a significant asymmetric impact on the upper-tail dependence and lower-tail dependence for the U.S. and Canadian equity markets. There is weak evidence of an asymmetric effect of the bilateral exchange rate for the U.S. and U.K. equity markets.

Oil and US stock market shocks: Implications for Canadian equities

AbstractOil and US stock market shocks are relevant to Canadian equities because Canada is an oil exporter exposed to market developments in the wider continent. We evaluate how the relationship between Canadian stock market indices and such external shocks change under extraordinary events. To do this, we subject statistically identified oil and S&P 500 market shocks to a surprise filter, which detects shocks with the greatest magnitude occurring over a given lookback period, and an outlier filter, which detects extrema shocks that exceed a normal range. Then, we examine how the dependence structure between shocks and Canadian equities change under the extreme surprise and outlier episodes through various co‐moment spillover tests. Our results show co‐moments beyond correlation are important in reflecting the changes occurring in the relationships between external shocks and Canadian equities in extreme events. Additionally, the differences in findings under extreme positive and negative shocks provide evidence for asymmetric spillover effects from the oil and US stock markets to Canadian equities. Moreover, the observed heterogeneity in the relationships between disaggregated Canadian equities and shocks in the crude oil and S&P 500 markets are useful to policy‐makers for revealing sector‐specific vulnerabilities and provide portfolio diversification opportunities for investors to exploit.

Market versus limit orders of speculative high-frequency traders and price discovery

The Korea Composite Stock Price Index (KOSPI) 200 futures market is one of the largest and most liquid index derivatives markets globally. We utilize high-quality intraday data on KOSPI 200 futures and find that high-frequency traders’ (HFTs’) market orders contribute much more to price discovery than their limit orders, as opposed to the findings of Brogaard, Hendershott, and Riordan (2019) in the Canadian equity market. To explain this phenomenon, we suggest that HFTs in the KOSPI 200 futures market are more speculative traders rather than market makers, which makes market orders more informative.

COVID-19 pandemic, stock returns, and volatility: the role of the vaccination program in Canada

ABSTRACT This paper examines how stock returns and volatility in the Canadian stock market have been affected by both the COVID-19 pandemic and the associated vaccination program. The empirical analysis is based on the generalized autoregressive conditionally heteroskedastic model which explicitly allows the inclusion of information on the COVID-19 pandemic and the vaccination program. The analysis uses daily Canadian equity returns and volatility, spanning the period 27 January 2020, to 31 August 2021. The findings provide evidence that the COVID-19 pandemic exerts a significant negative impact on the mean of Canadian stock returns and a positive impact on their volatility. In contrast, the findings provide novel evidence that the vaccination program in Canada has reversed these detrimental effects.

Politics and equity markets: Evidence from Canada

We examine how political power, polarization, and economic policy uncertainty (EPU) in Canada and the US affect the Canadian equity market from 1985 to 2019. We document little evidence of significant liberal government return premiums and the corresponding risk for the overall market and many industry sectors. Only the IT sector witnesses the “second half effect” of election cycles. The Canadian equity market seems to outperform during strong Democratic control in the US, with mixed findings for the individual sectors. Political polarization in the two countries and trade uncertainty have little impact on Canadian equity returns except for the venture, small-cap, and IT sectors from the US polarization. The US EPU index affects the average returns of the overall Canadian equity market and the energy, industrials, retail, and transportation industries, while domestic EPU in Canada reduces the overall equity market, small-cap, and venture firm returns. The alignment of political ideology in the two countries has little impact on the equity market in Canada. Collectively, the results show that the impact of political environments on the Canadian equity market tends to be limited, dynamic, and industry-specific, suggesting that investors should not blindly mix their portfolios with their political views or affiliations.

The oil price crisis and contagion effects on the Canadian economy

ABSTRACT Using a multifactor model, this paper investigates industry-level sensitivities to oil price changes and their spillover effects on 11 economic sectors in Canada during the 2014–2016 oil price crisis through a multisector analysis of sectoral equity indices. The three-factor model proposes a benchmark for interdependence between different sectors and examines the contagion effects transmitted via a common factor, a global oil factor, and a factor specific to the domestic oil and gas (O&G) sector during the crisis period. We provide empirical evidence of a strong and positive relationship between the global oil factor and the Canadian equity market. Results show that all sectoral equity portfolios are exposed to the global oil price. Also, though most economic sectoral portfolios experience contagion effects from the global oil market during the crisis period, some sectors show resilience. Finally, we find limited evidence on the effect of shocks originating in the O&G sector on other sectors of the Canadian economy. Our findings have implications for policy makers, managers and investors.

The effect of US macroeconomic news announcements on the Canadian stock market: Evidence using high-frequency data

We analyze the impact of US macroeconomic news announcements on the Canadian benchmark stock index return and volatility using high-frequency 5-min data. Our findings reveal that several US news releases exert a statistically significant influence on the Canadian stock market return and volatility. Moreover, we show that during the 2008 US recession, slightly more US news announcements exhibit significant impacts on the Canadian equity returns, with relatively pronounced effects. Overall, our results support previous findings by suggesting that US macroeconomic fundamentals form a linkage between Canadian and US financial markets.

Do High-Frequency Traders Improve your Implementation Shortfall?

We take advantage of a regulatory change that effectively imposed a “tax” on HFT order activity on Canadian equity venues to study the resulting effect on the execution costs of large institutional trades. We find that bid-ask spreads increase and price impact decreases for these trades following the regulatory change. The price impact effect is strongest for informed institutional traders. Our evidence indicates that this tax on high-frequency trading is associated with higher transaction costs for small, uninformed trades and lower transaction costs for large, informed trades. Hence, the tax increased the subsidy for informed traders from uninformed traders.

Estimating the Equity Risk Premium and Expected Equity Rates of Return: The Case of Canada

It is common to use the average excess return of equities over bonds estimated over long time periods as an expected equity risk premium on the grounds that going back far enough covers most possible economic scenarios. But although this data is useful in guiding the exercise of judgment, it cannot substitute for judgment. Adding more years of data to the near century of Canadian stock and bond returns that inform today's estimate of the equity risk premium will not produce a “random walk” for a simple reason: the historic bond series is the result of a specific historic monetary policy. This is particularly true of and important for the case of Canada, where today's very low current bond yields reflect the emergence of the Canadian dollar as a reserve currency as well as the impact of unconventional monetary policy elsewhere.After analyzing the historic record of the Canadian equity risk premium and noting the need for adjustments when this premium is applied to the current anomalously low Canadian long‐term bond yields, the author reaches the following conclusions: The historic Canadian equity risk premium is approximately 5.0% (based on arithmetic returns), which is slightly lower than the roughly 6.0% value for the U.S. The historic equity risk premium has not been constant because of obvious changes in the Canadian bond market. To some extent, the huge cycle in which bond yields began their increase from the 4.0% level starting in 1957, when markets were liberalized, and then fell back to the 4.0% level in 2007‐2008 completed an adjustment to changes in fiscal versus monetary policy. However, in 2016, average long Canada bond yields dropped to an anomalously low 1.8%, which is below the long‐term inflation target of the Bank of Canada, and have barely recovered since. It is difficult to view this as an equilibrium rate determined by private investors. Of the drop in bond yields, about 0.50% is unique to Government of Canada bonds as they became attractive to sovereign investors as a rare AAA‐rated issuer. Using an indicator variable for the post‐2010 years, a simple regression analysis indicates that current long Canada bond yields should be about 2.75% higher but for the recent changes. And for 2018, this means that the 2.35% average long Canada bond yield should have been about 5.0%. Apart from the impact of higher government deficits, this is consistent with average yields before the 2008 financial crisis. Adding an adjusted 5.0% long Canada bond yield to the historic equity risk premium in Canada of 4.50% gives 9.50% for the cost of the overall equity market or, given the Bank of Canada's target inflation rate of 2.0%, a real equity return of 7.5%, both slightly higher than the long‐run averages. In sum, the conventional practice of adding a historic market risk premium to the current low Canada long bond yields would impart a sharp downward bias to current equity cost estimates; use of this method would not be appropriate until long Canada bond yields increase to at least the 4.0% level.

The Equity Risk Premium and Six Decades of Risk and Return in Canadian Equity Markets (1958 – 2017)

We investigate the risk and return relationships of stocks, bonds and T-bills over the past six decades in Canada (1958 to 2017) and provide insights on some conventional folklore on a myriad of risk and return issues including investment duration. We also investigate the impact of NAFTA and the financial crisis on risk and returns as well as the impact of investment management fees on investor wealth. Our overall results indicate that the arithmetic risk premium in the Canadian equity market is 5.3% on short term T-bills and 3% on long term government bonds. The corresponding values for geometric average are 4.1% and 2.2%, respectively. The paper additionally presents many relevant stylized facts including the observation that the total shareholder return (TSR) is entirely attributable to the assumption about reinvestment of dividends.

Regulating dark trading: Order flow segmentation and market quality

We examine the impact of a rule in the Canadian equities market that requires dark orders to offer price improvement over displayed orders. We show that this rule eliminated intermediation of retail orders in the dark and shifted retail orders onto the lit market with the lowest trading fee. Intermediaries shifted liquidity supply to this market leading to increased displayed liquidity. We conclude that reducing retail order segmentation enhances lit liquidity. Despite the improvement in liquidity, retail traders receive less price improvement. Retail brokers pay higher trading fees to exchanges, and high-frequency traders earn higher revenues from trading fees.

Passive-Aggressive Trading: The Supply and Demand of Liquidity by Mutual Funds

Fund managers can demand liquidity for their trading ideas or provide liquidity for others’ ideas. We identify the roles of these motives using a database of the individual transactions by Canadian equity funds. Both the cost and subsequent performance of their buys decline after strong inflows, indicating the depletion of ideas and substitution into liquidity provision as funds put new money to work. Sales show little of this substitution, consistent with funds’ narrower latitude to provide liquidity to buyers. In general, the option to provide liquidity makes fund returns positive in the transactions costs of buys, but not of sells.

A global network topology of stock markets: Transmitters and receivers of spillover effects

This paper applies a bivariate cross-quantilogram approach to examine the spillover network structure in the stock markets of 58 countries according to bearish, normal and bullish market scenarios. Our aim is to identify the strongest interdependencies, the directionality of the spillover risk effects, and to detect those equity markets with the potential to cause global systemic risk. The results highlight the role of the US and Canadian equity markets as major spillover transmitters, while the stock markets of Romania, Taiwan and Mexico act mainly as spillover receivers. Particularly strong spillovers are observed from the Canadian and US equity markets towards the Irish market, and from the Brazilian equity market towards the Kenyan equivalent. The equity market networks suggest that only the US equity market can trigger systemic risk on a global scale. Implications of the results are discussed.

Interpreting the Estimates from the Full VECH Model with Asymmetry: The Case of US and Canadian Equity Prices

This paper attempts to derive careful interpretation of the parameter estimates from one of the multivariate generalized autoregressive conditional heteroscedasticity (MGARCH) models, the full vector-half (VECH) model with asymmetric effects. We also consider and interpret the parameter estimates from a case study of US and Canadian equity index returns by applying this model. More specifically, we firstly inspect the model formula and derive general interpretation of the model parameters. We consider this is particularly useful for understanding not only the full VECH model structure but also similar MGARCH models. After the general considerations, we also interpret the case results that are derived from our application of the full VECH model to US and Canadian equity index returns. We consider that these concrete illustrations are also very helpful for future related research.

Regulating Dark Trading: Order Flow Segmentation and Market Quality

We examine the impact of a rule in the Canadian equities market that requires dark orders to offer price improvement over displayed orders. We show that this rule eliminated the intermediation of retail orders in the dark and shifted retail orders onto the lit market with the lowest take fee. Intermediaries shifted liquidity supply to this venue leading to an increase in displayed liquidity. We conclude that reducing retail order segmentation enhances lit liquidity. However, retail traders receive less price improvement, retail brokers pay higher exchange fees, and institutions incur higher implementation shortfall. High frequency traders earn higher fee revenues.

Do actively managed funds perform better than index funds? A test in the Canadian market

Actuality of the study: Mutual funds are a favourite investment product among many investors. They provide a simple means of diversification, especially for those with smaller amounts of capital, and the popularity of mutual funds has increased with the success of the marketing efforts behind them.
 Purpose: This study evaluates the performance of actively managed and index mutual funds within the Canadian equities market.
 Findings: As index investing has increased in popularity, and other markets have become more connected and open, there is a need for research on equity mutual funds in countries outside the US.
 Originality / Value: The majority of previous research on index funds and actively managed mutual funds is focused on the US market and related indexes such as the S&P 500.
 Practical implications: This study suggests that, on average, active funds in Canada fail to beat their benchmarks net (but not gross) of the common fee or management expense ratio. Surprisingly, this research finds no positive relationship between higher fees and better gross performance. Actively managed funds also have poorer performance over the long term. This study finds that investors would be better off purchasing low cost index funds as they provide a more secure return.
 Future research: This study endorses research on other markets with inclusion of additional variables in order to explain gross performance and secure returns.

Information Variables and Equity Premium Predictability: Canadian Evidence

This paper presents the most comprehensive out-of-U.S.-sample examination of information variables and equity premium predictability by focusing on Canada. Using monthly data for 36 variables from 1950 to 2013, we test their individual predictive ability and provide a new empirical assessment of the related econometric issues. We find conclusive and robust evidence of in-sample, out-of-sample and economically meaningful predictability of the Canadian equity premium, providing guidance on each variable as a market indicator. Our results generally support the existing evidence in favor of predictability, but cast doubt on some variables that have been successful predictors for the U.S. equity premium.

Performance of Canadian hybrid mutual funds

The risk-adjusted selectivity performance (alphas) of a comprehensive and survivorship-free sample of Canadian hybrid funds after (before) management-related costs is negative (neutral) and deteriorates when we control for fixed-income exposures and not for conditioning information. Fund performance is positively related with the asset allocation to Canadian Equity and with whether the fund family’s orientation is tilted more to equity or bond funds. Examination of funds in the tails of the performance distribution using the block-bootstrap method suggests that “good luck” explains the before and after costs outperformance of extreme right-tail funds and no fund possesses truly superior management skills.

Out of Asia: Topologies of Racism in Canada

This case study recounts my harrowing experience through a great Canadian equity swindle—involving two internal university equity investigations, BC Human Rights Tribunal, and the BC Supreme Court—to bring to account a deeply flawed and allegedly discriminatory academic hiring process. I situate my human rights complaint in the larger socio-political context of Canada becoming “too Asian.” Using a methodology of a critical personal narrative in the form of a self-interview, I discuss how diverse actors from the union to lawyers, the court system, the media, the public, and fellow academics stubbornly refuse to see the nexus between race and discrimination. These embarrassing conversations form the contours of topologies of race in Canada, stretching and bending our academic, legal, media, and social landscapes without tearing white hegemony apart. I highlight the common experiences of fellow human rights complainants who contacted me during this period and the implications of our ordeals on the Canadian social body.

The Pricing of Liquidity Risk and Accounting Quality in Canada

I investigate the pricing of liquidity risk and accounting quality in Canadian equity markets. I report evidence that security prices in Canada are significantly affected by liquidity risk, and that this association is significant throughout the year, with a spike in January. However, despite positive correlation between the accounting quality and liquidity factors, the accounting quality factor is not significantly different from zero except in January, and firm-specific estimates of exposure to the accounting quality factor (i.e. factor betas) have no predictive power for future returns. I conclude that while investments in accounting quality could possibly mitigate liquidity risk, accounting quality is unlikely to have a direct effect on the cost of capital of Canadian firms.