Capital Asset Pricing Research Articles

Forecasting Daily Stock Volatility Using GARCH-CJ Type Models with Continuous and Jump Variation

Abstract. In this paper we decompose the realized volatility of the GARCH-RV model into continuous sample path variation and discontinuous jump variation to provide a practical and robust framework for non- parametrically measuring the jump component in asset return volatility. By using 5-minute high-frequency data of MASI Index in Morocco for the period (January 15, 2010 - January 29, 2016), we estimate parameters of the constructed GARCH and EGARCH-type models (namely, GARCH, GARCH-RV, GARCH-CJ, EGARCH, EGARCH-RV, and EGARCH-CJ) and evaluate their predictive power to forecast future volatility. The results show that the realized volatility and the continuous sample path variation have certain predictive power for future volatility while the discontinuous jump variation contains relatively less information for forecasting volatility. More interestingly, the findings show that the GARCH-CJ-type models have stronger predictive power for future volatility than the other two types of models. These results have a major contribution in financial practices such as financial derivatives pricing, capital asset pricing, and risk measures. Keywords. GARCH-CJ, Jumps variation, Realized volatility, MASI Index, Morocco. JEL. C22, F37, F47, G17.

Risk-taking channels and capital inflows into the US treasuries

This letter explores dynamic interactions among capital inflows, asset prices, and leverage. A VAR model provides evidence that expansionary shocks to capital inflows into the US Treasuries lead to higher leverage by inducing appreciation in relative asset prices.

Capital Flows, Asset Prices and Output in Emerging Market Economies

In this article we construct a simple open-economy macro model to examine how capital flows, monetary policy and dividend policies of firms influence asset prices, economic activity and inflation. In this model, we consider a three-asset framework based on domestic money, domestic equity and foreign bonds under flexible exchange rate. The model is based on the assumptions of imperfect asset substitutability and absence of sterilization. The model also incorporates an aggregate supply function in the presence of wage indexation. The model can apply to a large class of emerging market economies which have embarked on a programme of liberalization of the financial sector in general and stock market in particular.

Portfolio Optimization

Selects a method of optimal portfolio is a reflection of the fact that investors are not only operating in different stages of the investment process, but also know the nature of this business. Set of basic knowledge to understand the problems of portfolio selection consists of a portfolio assessment parameters, based on the fundamental aspects of each investment, especially from the proceeds and investment risk, also for reasons of construction and portfolio selection, where the construction of the portfolio is an investment strategy that allows you to optimize the overall rate of return investment for the risk. Another fundamental aspect is the size parameter reinsurance portfolio to ensure the use of statistical relationships and probability. Aspect of the existence of logical and psychological aspects of portfolio selection is a psychological aspects related to investor risk. The most important part is the portfolio optimization, effective and efficient portfolio frontier models and pricing of capital assets - CAPM, CML, SML.

An Analytic Derivation and Comments on Betting Against Beta

I present a closed form solution to the OLG model in Frazzini and Pedersen (2014), and find that their OLG model of heterogeneous investors results in the zero-beta CAPM. I prove that the optimal amount to invest in risky assets for an investor is determined exactly by her risk aversion, margin requirement and wealth. Thus every investor's optimal portfolio is explicitly solved and the market portfolio is easily aggregated on the mean-variance frontier. Working with the analytic formulas, I provide a rigorous derivation of their theoretical results and discuss the implications of the Z-factor, which is market neutral, and must be the second factor other than the market factor in capital asset pricing.

An Assessment of Recent Market Performance of REITs in a Developing Economy

The study appraised the recent performance of Real Estate Investment Trust (REIT) as a new investment vehicle in Nigeria. While REITs are often presented as useful tools for diversification, little is known about the variations in the empirical correlations between the country’s REITs’ returns and the general market index. The paper addresses this issue using published data over the first four trading years (2008 – 2011) of Skye Shelter Fund, the country’s premier publicly traded REIT. Data inquiry schedules were developed to gather annual market and REIT’sreturndata based on the analytical framework provided by Capital Asset Pricing Model.Using regression analysis, the results of the study showed that the Nigerian REIT wasweaklycorrelated to the broad market during the 4-year period of the analysis. The findingssupport the importance of REITas a relatively low-risk, stableasset class that investors can leverage for building sustainable optimal portfolios, particularly during periods of heightened macroeconomic uncertainties of the kind witnessed during the 2008 global financial crisis.The significance of this research is the potential to chart the way forward by presenting investment opportunities in REITfor policy makers, international development institutions, financial organisations, and research centres.

Dividend Announcements and Capital Asset Pricing: Is There a Clientele Effect?

According to the efficient market hypothesis, publicly available information is accessible to all investors at zero cost. Therefore, the security prices might adjust to information as soon as it becomes publicly available. The purpose of the study is to investigate the impact of the announcements of dividends on the price of the stock listed with Dhaka Stock Exchange (DSE). Stock market reactions to dividend announcements introduced the concept of event time, which may well have been the single most important breakthrough in our understanding of how stock prices respond to financing information. The present study is entirely an analytical presentation concentrating on corporate dividends over time which attempts to analyse different theoretical models in explaining the impact of dividend on stock price of the firms on DSE. The findings suggest that there exists announcement impact of dividend on stock price. The most significant price changes occurred in the days prior to the announcement date.

Liquid Assets, Illiquid Assets and Sunspots

In this paper, I first show that liquid assets make risk-averse agents better off by eliminating multiple equilibria and thus eliminating speculation based on nonfundamentals. I then show that illiquid assets make risk-averse agents worse off by enlarging the set of economies (or agent preferences) that give rise to sunspot equilibria. In addition, my results show that with illiquid assets, nonfundamental volatility results as follows: In order to smooth consumption, some agents endogenously create private claims backed by these illiquid capital assets. These claims have multiple price equilibria, and their fluctuating prices cause the prices of the illiquid capital assets to fluctuate as well. The excess volatility makes all risk-averse agents worse off (in a Pareto sense). My model also shows equilibrium idiosyncratic risk bearing in illiquid asset markets by certain segments of the population which should be of concern to regulators and policy makers. For example, in real estate markets, there is a role for government intervention and for government-supplied liquidity and for its active management.

Asset pricing with disequilibrium price adjustment: theory and empirical evidence

Breeden [J. Financial Econ., 1979, 7, 265–196], Grinols [J. Finance, 1984, 39(5), 1571–1595] and Cox et al. [Econometrica, 1985, 53, 363–384] describe the importance of including the supply side in capital asset pricing. Black [Am. Econ. Rev., 1976, 66, 767–779] derives a dynamic, multi-period CAPM, integrating endogenous demand and supply. Based upon the papers of Black and Lee et al. [Q. Rev. Econ. Finance, 2009, 49, 811–828], we first derive a simultaneous equation asset pricing model. Then we test the simultaneous equation asset pricing model in terms of the disequilibrium models developed by Fair and Jaffee [Econometrica, 1972, 40, 497–514], Amemiya [Econometrica, 1974, 42, 759–762], Quandt [The Econometrics of Disequilibrium, 1988], and others. We also discuss two methods of estimating an asset pricing model with a disequilibrium price adjustment effect. Finally, using price per share, dividend per share, and shares outstanding, we empirically test the existence of a price disequilibrium adjustment process with international index data and U.S. equity data. We find that a disequilibrium price adjustment process does, in fact, exist in our empirical data. Our results support the finding of Lo and Wang [Rev. Financial Stud., 2000, 13, 257–300] that trading volume is an important factor in capital asset pricing.

Foreign Exchange Rate and Its Place in Capital Asset Pricing Model

With respect to currency market and these problems are closer to it such as foreign currency translation and effect on prices of capital assets, to estimate actually required return of capital assets, we should consider these variable to our models. Therefore the concept of the capital asset pricing model (CAPM) is extended to international investments. This subject is emphasized by management on the one hand and investors on the other hand. When looking at investments in an international setting, incorporate foreign exchange risks are introduced. Some of the international capital asset pricing models are limited to one factor and others are multifactor models with attention to foreign currency that impact of the portfolio. Globalization and expansion of investment activities in different markets led to introduce and developed an international capital asset pricing model. This model evaluates the performance of various components of the investment portfolio that they composed of a variety of unlike the currency basis. Furthermore, the model in various financial markets, aggregate and transforms their results based on a uniform currency basis in the interpretation of results, and it's generalized to other sectors. Finally, it can provide comprehensive perspectives for investors.

Capital Asset Pricing Under Ambiguity

This paper generalizes the standard mean–variance paradigm to a mean–variance– ambiguity paradigm by relaxing the assumption that probabilities are known and instead assuming that probabilities are themselves random. It extends the CAPM from risk to uncertainty by incorporating ambiguity. This model makes the distinction between systematic ambiguity and idiosyncratic ambiguity and proves that the ambiguity premium is proportional to systematic ambiguity. It introduces a new measure of uncertainty that combines risk and ambiguity. Use of this model can be extended to other applications including portfolio selection and performance measurement.

Validity of capital asset pricing model in Pakistan: Evidence from Karachi Stock Exchange

This study investigates the validity of capital asset pricing (CAP) model in Karachi Stock Exchange (KSE). The data used in this study were collected from 387 companies of 30 different sectors on monthly, quarterly and semi-annual basis. The Paired sample t- test is applied to find the difference between actual and expected returns. Results show that capital asset pricing model (CAPM) predict more accurately the expected return on a short term investment as compare to long term investment. It is recommended that the investors should more focus on CAPM results for short term as compare to long term investments in KSE.

A short note on the Growth Potential of risky fund investments

Several important breakthroughs within portfolio theory, capital asset pricing and return volatility have been made in the past few decades. Together with the liberalization of international capital asset trading, the global markets are set for an ever-improved efficiency and stability in the near future. Yet, from a small bank client's viewpoint, little has changed during almost five decades within the domain of financial investment support offered by the banks. With the focus of the contemporary research placed on advanced issues within portfolio theory, well-functioning financial markets and the growth impact of the banking sector, it seems as if the decision needs of the small bank client have been largely neglected. The risk measures currently used do not focus on the time of entry in a risky investment. Selecting a wrong entry point for fund investments can usually not be compensated by active governance within a reasonable investment period. In order to utilize the common practices in mutual fund investment services of the banks, a significant amount of knowledge of the underlying mechanisms of asset pricing and the fund dynamics is required from the investor. In the current note, we present a simple statistic, the Growth Potential Index (GPI), which captures the essential characteristics of relevance for determining the time of entry in a mutual fund investment. The mirror image of the GPI, the Decline Potential Index (DPI), is also presented. The DPI may provide valuable decision support information for specifying the time of exit from a long position in the fund. As GPI and DPI are simple to understand and calculate and contain valuable decision support information for a small client, their inclusion in the websites would seem to be a worthwhile effort for any esteemed financial institution offering stock governance services.

Is There Room for Bulls, Bears, and States in the Circuit?

This paper takes off from Jan Kregel's paper Shylock and Hamlet, or Are There Bulls and Bears in the Circuit? (1986), which aimed to remedy shortcomings in most expositions of the approach. While some circuitistes have rejected John Maynard Keynes's liquidity preference theory, Kregel argued that such rejection leaves the relation between money and capital asset prices, and thus investment theory, hanging. This paper extends Kregel's analysis to an examination of the role that banks play in the circuit, and argues that banks should be modeled as active rather than passive players. This also requires an extension of the circuit theory of money, along the lines of the credit and state money approaches of modern Chartalists who follow A. Mitchell Innes. Further, we need to take Charles Goodhart's argument about default seriously: agents in the circuit are heterogeneous credit risks. The paper concludes with links to the work of French circuitist Alain Parguez.

Strategic Behavior in Capital Markets and Asset Prices

Strategic Behavior in Capital Markets and Asset Prices

Capital Structure Dynamics and Stock Returns

Many finance theories predict that the capital structure affects firm value, which implies that the changes in leverage have an impact on stock returns. Most of the existing literature however has been focusing on the determinants of the capital structure. Using a sample of U.S. public firms during 1975-2002, we document a significantly negative effect of leverage changes on next-quarter stock returns. This effect remains significant after controlling for other firm characteristics such as ROE, book-to-market, firm size, and past returns. We propose and test several hypotheses to explain the observed effect. We find that the negative effect is stronger for the firms with a higher leverage level. This is consistent with a dynamic view of the pecking-order model that an increase in leverage reduces firms' debt capacity and may lead to future underinvestment. Further tests confirm the negative effect of current leverage change on future investment. In contrast, our results cannot be explained by the trade-off theory, default premium, the market timing theory, or the operational signaling story. Specifically, we find that deviation from the target leverage ratio has no impact on the stock returns, inconsistent with the trade-off theory (which implies an optimal, or partially optimal, leverage ratio). In addition, the change of long-term debt affects stock returns more than the change of short-term debt, and the one-year expected return following leverage change does not increase, both of which are inconsistent with the default risk premium hypothesis. Our results are not driven by firms' market timing activities. A firm times the market by issuing new equity (repurchasing stocks) when its equity is over- (under-) valued, which implies a positive relation between the leverage change and stock return. We also do not find support for the view that leverage increase signals poor future operating performance. Finally, we show that the return effect of leverage change contains information that cannot be explained by the popular pricing factors. This sheds new light on the link between capital structure choice and empirical asset pricing.

How to Understand High Food Prices

AbstractAgricultural price booms are better explained by common factors than by market‐specific factors such as supply shocks. A capital asset pricing model‐type model shows why one should expect this and Granger causality analysis establishes the role of demand growth, monetary expansion and exchange rate movements in explaining price movements over the period since 1971. The demand for grains and oilseeds as biofuel feedstocks has been cited as the main cause of the price rise, but there is little direct evidence for this contention. Instead, index‐based investment in agricultural futures markets is seen as the major channel through which macroeconomic and monetary factors generated the 2007–2008 food price rises.

The Impact of Corporate Governance on the Cost of Equity: Empirical Evidence from Pakistani Listed Companies

This study examines the impact of the quality of corporate governance, as measured by a specially constructed corporate governance index, on the expected cost of equity calculated using the capital asset pricing model (CAPM) approach. A total of 114 listed companies were investigated to analyze the relationship between the two variables for the period 2003 to 2007. The quality of corporate governance was measured by assigning weights to a set of related variables, although these variables were also considered individually. We used descriptive statistics, a correlation matrix, a simple ordinary least squares (OLS) approach, and fixed effect model to test the panel data collected. We found a negative relationship between managerial ownership and board size with the cost of equity, and a positive relationship between board independence, audit committee independence, and corporate governance with the cost of equity. These results could be due to the transition phase through which Pakistani companies are passing after the promulgation of the Code of Corporate Governance in 2002.

A note on capital asset pricing and heterogeneous taxes

In this paper, we present a stylized model where we show how asset prices, i.e., required expected rates of returns, may be characterized in a world with heterogeneous asset taxes. Within a simple CAPM-like framework, we derive an after-tax beta equal to the pre-tax beta multiplied by a (non-obvious) asset specific tax adjustment. We further show in what sense the Security Market Line here can be replaced by a Security Market Fan. Well-known CAPM relations are obtained as special cases, and policy implications are analyzed.

From the Efficient Market Hypothesis to Behavioral Finance: How Investors' Psychology Changes the Vision of Financial Markets

This paper confronts the main foundations of the neoclassical theory of the capital market and asset pricing with allegations of behavioral finance. Cornerstones of the traditional theory are discussed in the first section. It is followed by a brief presentation of the behavioral approach. Further, the paper discusses consequences of the new view of finance to capital market practitioners - investors, corporate finance, and policy-makers. The paper concludes with final remarks and some thoughts on the future development of the capital market theory.