Return Comovement Research Articles

Common features in UK commercial real estate returns

This paper examines the degree of short run co-movement in UK commercial real estate returns. The hypothesis is that a large fraction of the fluctuations may result from a small number of core disturbances that are transmitted from one region to another and from one property type to another. It adopts an approach from the business cycles literature which uses common features, and their complement, common cycles. The empirical modelling follows the work by Tiao and Tsay (1985), Engle and Kozicki (1993), Vahid and Engle (1993, 1994) and Engle and Issler (1995). Thirty-nine regional rates of return series are used, covering retail, office and industrial real estate for the economic planning regions of the UK. For the series that exhibit serial correlation, bivariate and multivariate common feature/common cycle tests are performed and reduced dimensional VAR models are estimated. The results suggest a single common cycle for the retail and industrial markets and three common cycles in the office market. The existence of common features is important in the study of commercial returns as, when common features exist, uncovering these enhances understanding of the returns generating process. Moreover, this assists in understanding the scope for diversification within real estate portfolios. The results offer important insights into the links between regional real estate markets, not least because they are consistent with previous studies using very different approaches.

Tests for breaks in the conditional co-movements of asset returns

Tests for breaks in the conditional co-movements of asset returns

What's My Line? A Comparison of Industry Classification Schemes for Capital Market Research

This study compares four broadly available industry classification schemes in a variety of applications common to capital market research. SIC codes have been available since 1939, but are being replaced by NAICS codes. The Global Industry Classifications Standard (GICS)SM system, jointly developed by SP FF)) algorithm is devised by academics. Our results show that GICS classifications are significantly better at explaining stock return co-movements, as well as cross-sectional variations in valuation-multiples, forecasted and realized growth rates, R&D expenditures, and various key financial ratios. The GICS advantage is consistent from year-to-year and is most pronounced among large firms. The other three methods differ little from each other in most applications.

Cross-currency, cross-maturity forward exchange premiums as predictors of spot rate changes: Theory and evidence

This paper shows that, in predicting the spot rate of a currency, the term structures of forward premiums of other currencies have incremental information content in addition to the term structure of the currency's own forward premiums. The theoretical model motivating the analysis hinges on the abundant evidence on the co-movements of excess returns from investing in different currencies. The empirical results are obtained through FIML estimation of a vector error correction model for weekly data on three bilateral US dollar exchange rates.

Time-varying risk preferences and emerging market co-movements

This paper examines how shocks can transmit across international stock markets through the channel of time-varying investor risk preferences. We highlight the effects of this channel by comparing the conventional constant relative risk aversion utility function with the habit-formation utility function of Campbell and Cochrane (J. Pol. Econ. 107 (1999) 205). Calibrating our model with data from Argentina, Korea and Mexico, we find that in the presence of time-varying investor risk preferences, market integration generates a substantial increase in cross-country co-movements of stock returns.

International equity market comovements: Economic fundamentals or contagion?

We investigate the return comovement in international equity markets with a focus on the distinction between economic fundamentals and contagion. We examine the potential macro news effect based on a comprehensive data set of macroeconomic news announcements made in the U.S., U.K., and Japan. Our results show that the bulk of the observed comovement in the intraday and overnight returns of the international equity markets cannot be attributed to public information about economic fundamentals. In contrast, foreign market returns exert a dominant influence on the subsequent domestic market returns. Overall, our findings suggest that future inquiry on market comovement may focus on the distinction between contagion and trading on private information, rather than public information.

Massively Confused Investors Making Conspicuously Ignorant Choices (MCI–MCIC)

ABSTRACTThis paper examines the comovement of stocks with similar ticker symbols. For one such pair of firms, there is a significant correlation between returns, volume, and volatility at short frequencies. Deviations from “fundamental value” tend to be reversed within several days, although there is some evidence that the return comovement persists for longer horizons. Arbitrageurs appear to be limited in their ability to eliminate these deviations from fundamentals. This anomaly allows the observation of noise traders and their effect on stock prices independent of changes in information and expectations.

The Effects of the Asian Crisis on Global Equity Markets

AbstractWe investigate the comovement of daily returns from 13 Asian and non‐Asian markets before and after the advent of the Asian crisis in July 1997. For individual pairs of markets, our analysis shows a seven‐fold increase in feedback relations. For the markets as a group, we find a reduction in the number of common factors that generate returns. Since the post‐crisis period included the collapse of the Russian market and attack on the Brazilian real, we also analyze six three‐month subperiods surrounding the crisis. We find that the perceived increase in comovement during the post‐crisis interval was the result of subperiod transitory shocks.

On Stock Market Return Co-Movements: Macroeconomic News, Dispersion of Beliefs, and Contagion

We document and explain the return co-movement for the U.S., U.K., and Japanese equity markets for the period of 1985-1996. Our empirical results show the importance of imperfect signal-extraction in explaining the equity market return co-movement. In such a setting, domestic investors try to extract the unobservable global factors from foreign market returns and use the extracted information in their subsequent domestic trading. In this imperfect learning environment, domestic investors respond to the foreign return signal more strongly if the signal is more precise. In addition, trading noise may also affect the return-generating process in domestic markets. We find this contagion effect is most pronounced in the extreme down markets.

Advanced Trading Rules

THE JOURNAL OF ALTERNATIVE INVESTMENTS 91 F or stock and bond investments, previous research has linked mutual fund performance with underlying market returns. However, when it comes to non-traditional investment vehicles such as hedge funds and managed futures, very little attention has been given to describing the fundamental factors determining hedge fund or managed futures returns. This is important for several reasons. First, hedge funds and, more specifically, commodity trading advisors, have different trading styles (e.g., long and short positions) or trading opportunities (e.g., commodity and financial markets) than traditional stock and bond mutual fund managers. As a result, compared to stock and bond funds, other factors such as trending market prices or market volatility may better capture their relative return movement. Advanced Trading Rules, edited by Emmanual Acar (a well-respected professional proprietary trader with Dresdner Kleinwort) and Stephen Satchell (a Cambridge University academic), puts together twelve leading investment professionals and academics who present a wide range of examples as current ideas on the application of trading rules and trading system designs. More precisely, the book contains five chapters on the underlying return process of various futures and options markets and how various trading rules or strategies may or may not capture the underlying return patterns. In the second section, three authors (in three chapters) test whether advances in trading systems such as artificial neural networks, traditional trading rules such as head and shoulders, and fundamental economic information can be beneficial in developing profitable trading rules in the foreign exchange market. In the final section, four chapters are presented in which the benefits of actual technical trading systems are reviewed and the performance of managed futures programs are analyzed in terms of their underlying trading style. This collection of articles is important. While previous research has indicated the potential benefits of including managed futures and hedge funds in stock and bond portfolios, the unique explanatory return factors, especially systematic trading rules, that led to the differential return comovement of managed futures and hedge funds with traditional stock and bond funds has not been fully explored. While none of the articles produce gold out of lead, they do show how modern alchemists treat their art. As important for asset managers as it is for academics, the book provides a look into how our competitors are moving forward. But, let the buyer beware, for some of these articles you may need to refresh your knowledge of college statistics or bribe your college-age son or daughter to explain some of the specifics of ∑, λ, and ∞.

Macroeconomic Announcement Effects on the Covariance Structure of Bond Returns

This paper contains a multivariate analysis of the effects of macroeconomic news on the U.S. bond market. In particular, we consider releases of Employment Situation and Producer Price Index (PPI) reports (released monthly on pre-announced dates) and the excess returns of 2, 3, 5, 7, 10, and 30 year Treasury bonds using daily data from 1983 to 1998. We extend the work of Jones, Lamont and Lumsdaine (1998) who analyze macroeconomic announcement effects on bond returns in a univariate GARCH framework. Our main interest is the impact of macroeconomic news on the conditional variances, covariances, and correlations of bond returns. To this end, we apply the factor-ARCH model of Engle, Ng and Rothschild (1990) using the principal components as substitutes for the real common factors. One factor is shown to be adequate, accordingly, the first principal component is assumed to evolve according to a GARCH(1,1) model extended to account for differences between announcement and non-announcement days. In this way, we document that the conditional variance of the common factor is deterministically larger on announcement days by 164%. Moreover, announcement shocks are found to be merely transitory and do not tend to persist. Hence, macroeconomic news cannot explain the observed high degree of persistency of the bond market. In addition, we do not find any leverage effects of announcement shocks. The conditional variances of bond excess returns are significantly larger on announcement days and increase with maturity. Likewise, the conditional covariances are larger on announcement days and increase with the maturity of either bond. Finally, the conditional correlations are found to be larger on announcement days, i.e. the co-movement of bond excess returns is stronger on announcement days than on other days.

Economic determinants of evolution in international stock market integration

This study investigates how and why different pairs of national equity markets display differing degrees of co-movement over time. We interpret a greater degree of co-movement to reflect greater stock market integration. We hypothesize the extent of stock market integration may depend upon certain macroeconomic variables that characterize and influence the degree of economic integration between two countries. As the degree of economic integration varies over time for a given pair of countries, we may expect the extent of equity market integration to vary systematically. We empirically investigate this hypothesis by employing a two-step procedure to explore first, how the degree of co-movement for a given pair of markets varies over time and second, why this interdependence varies over time. First, we employ daily data for nine national equity markets over 22 yearly samples to estimate annual Geweke [J. Am. Statist. Assoc. 77 (1982) 304–313] measures of feedback for different pairs of markets. For each pair of markets, the time series of 22 annual Geweke measures reveals the evolution in how co-movement in daily returns varies over time. Second, we specify a set of macroeconomic variables that characterize and influence the degree of economic integration for each pair of countries. Finally, we incorporate these variables in a pooled time series regression model across all possible pairs of these nine markets to estimate the influence of macroeconomic determinants on evolution in stock market integration.

International Equity Market Comovements: Economic Fundamentals or Contagion?

We investigate the causes of the contemporaneous return comovement in international equity markets with a focus on the distinction between economic fundamentals and contagion. We examine the potential news effect based on a comprehensive data set of the macroeconomic news announcements made in the U.S., U.K., and Japan from 1985 to 1996. We report three major findings. First, foreign intraday trading significantly influences domestic markets even after we control for the macroeconomic news impact. This result is robust for all models and across all three countries. This suggests that foreign trading does convey information distinct from the public information flows, measured by the macroeconomic news announcements. Second, foreign market trading impacts domestic overnight returns more profoundly than domestic intraday returns. In our setup, domestic overnight returns precede domestic intraday returns for the same calendar day. Hence the bigger impact on the domestic overnight returns implies that domestic markets efficiently process the information disseminated from foreign market trading on a timely basis. Third, we find that although foreign macroeconomic news announcements have little measurable impact before the Crash in October 1987, their influence on domestic markets tend to increase after the Crash and, in particular, during the 90's. Furthermore, there is evidence that the effect of foreign macroeconomic news announcements increases when the announcements are accompanied with large movement in foreign intraday returns or when the volatility of the announcements is large. The increasing importance of these macroeconomic news announcements does not mitigate the influence of foreign market trading. In fact, our result shows that in each country the two foreign intraday returns are far more important than the preceding domestic returns and all macroeconomic news announcements taken together in explaining the variations in the domestic intraday and overnight returns. In one sense, our results suggest the potential importance of a contagion effect. Our results show that the bulk of the observed comovement in the intraday and overnight returns of the international equity markets cannot be attributed to public information about economic fundamentals. As a result, future inquiry on this issue may focus on the distinction between contagion and private information, rather than public information. Alternatively, future research on this subject may need to consider stock return data finer than the intraday and overnight returns employed in this paper.

The intertemporal stability of the covariance and correlation matrices of Hong Kong stock returns

The intertemporal stability of the covariance matrix of stock returns is important in using ex-post factor structures on the APT and in portfolio optimization, while that of the correlation matrix is important in examining the ex-ante diversification benefits and stock return co-movements. By using Box's M test and an extension of the test, the intertemporal stability of the covariance and correlation matrices, respectively, of Hong Kong stock returns during the 1981–1992 time period are studied. Empirical results show that the covariance matrix of stock returns is less stable intertemporally than the corresponding correlation matrix and the results are robust across four different investment horizons. In general, the longer the investment horizon, the larger is the degree of intertemporal stability on both the covariance and correlation matrices of stock returns.

The Risk and Return from Factors

The ability to identify which factors best capture systematic return covariation is central to applications of multifactor pricing models. This paper uses a common data set to evaluate the performance of various proposed factors in capturing return comovements. Factors as? sociated with the market, size, past return, book-to-market, and dividend yield help explain return comovement on an out-of-sample basis (although they are not necessarily associated with large premiums in average returns). Except for the default premium and the term pre? mium, macroeconomic factors perform poorly. We document regularities in the behavior of the more important factors, and confirm their influence in the Japanese and U.K. markets as well. I. Introduction This paper seeks to identify which factors are important for driving the com? mon variation in stock returns. We evaluate all the major factors that have been suggested in the existing empirical literature. Unlike earlier research that has been concerned with the determinants of expected returns, however, our main interest lies more in specifying the sources of return covariation regardless of whether they are priced or not. The identification of the sources of comovement and, hence, sources of portfolio risk, is an important issue for theoretical and applied reasons.

Why Do Markets Move Together? An Investigation of U.S.-Japan Stock Return Comovements

Why Do Markets Move Together? An Investigation of U.S.-Japan Stock Return Comovements

Why Do Markets Move Together? An Investigation of U.S.‐Japan Stock Return Comovements

ABSTRACTThis article explores the fundamental factors that affect cross‐country stock return correlations. Using transactions data from 1988 to 1992, we construct overnight and intraday returns for a portfolio of Japanese stocks using their NYSE‐traded American Depository Receipts (ADRs) and a matched‐sample portfolio of U. S. stocks. We find that U. S. macroeconomic announcements, shocks to the Yen/Dollar foreign exchange rate and Treasury bill returns, and industry effects have no measurable influence on U.S. and Japanese return correlations. However, large shocks to broad‐based market indices (Nikkei Stock Average and Standard and Poor's 500 Stock Index) positively impact both the magnitude and persistence of the return correlations.

Covariance and correlation stationarity: Experiences from seven Asian emerging markets

Because of the rising interest and the growing importance of the Asian emerging markets in international diversification, this paper examines the covariance and correlation stationarity in stock return relationships among seven Asian emerging markets. This paper also covers the issue of seasonality in stock return co-movements. Empirical results show that because the correlations among them and those with other developed markets are very small, huge gains from diversifying into the seven Asian emerging markets are possible. Results on stationarity indicate that correlation matrices of stock returns are much more stable then the corresponding variance-covariance matrices and that the length of the estimation period seems to have no impact on the stationarity of the correlation matrix. We also found that virtually no seasonality in the correlations exists among the seven Asian emerging markets. However, we did find that during our sample period covariance among stock returns is nonstationary in January.

Comovements of Low-Grade Debt and Equity Returns of Highly Leveraged Firms

Comovements of Low-Grade Debt and Equity Returns of Highly Leveraged Firms

The Time-Variation of Risk Premiums on Insurer Stocks

Introduction This article studies the economic determinants of risk premiums on insurer stocks. Using a life insurance stock index, a property-liability insurance stock index, and some financial and real estate variables, we address the following question: How do changing economic conditions affect the risk premiums on insurance stocks? It is important for insurers to understand the determinants of equity risk premiums since risk premiums affect not only their investment decisions but also their financing decisions. As is well known in the corporate finance literature, the weighted average cost of capital is a weighted average of the cost of debt and the cost of equity. The higher the equity risk premium, the higher the required rate of return on equity; thus, the higher the weighted average cost of capital. Higher equity risk premiums should lead to reductions in the promised minimum rates of return paid to some universal/variable policyholders since certain profit levels must be maintained in order to ensure risk-adjusted returns to shareholders. The variation of risk premiums is also of interest to regulators because it contains information about market perceptions of insurer risk and cost of capital. Thus, in states where policy premiums are regulated, regulators should allow for higher policy premium increases if there is substantial increase in the equity risk premium. Our study finds substantial variation in risk premiums on insurance stocks that is predictably based on a small set of economic variables. We also find that the risk premiums (expected excess returns) on insurer stocks and equity real estate investment trusts (REITs) have behaved in similar fashion. Preliminary evidence indicates that insurers have been perceived by the market to have increased their real estate risk exposure in the 1980s due to a turbulent real estate market, despite the fact that their actual holdings, as a percentage of assets, remained relatively unchanged during the period. We also find that the time variation in risk premiums could be explained by the changing price of risk of one or two systematic factors. This study employs a multifactor latent-variable model widely used in the finance literature to study the risk premium of market indices. The risk premium of insurance stocks has not been examined using this method. This methodology, which is designed to capture the movement in expected excess returns due to a changing economic environment, is appropriate for our purpose because it allows for time-varying risk premiums. Specifically, it provides a concise framework to study the co-movement of insurance stocks and real estate market returns. The next two sections outline the asset pricing framework and estimation procedure. They are followed by a description of our data set and an empirical study of the time variation in risk premiums on insurance stocks. A final section summarizes the results. The Asset Pricing Framework Using the multifactor latent-variable model of Campbell (1987), Campbell and Hamao (1992), and Ferson (1989), we begin by assuming that asset returns are generated by the following K-factor model: |Mathematical Expression Omitted~ where |Mathematical Expression Omitted~ is the return on asset i held from time t to time t+1, in excess of the Treasury bill rate. |Mathematical Expression Omitted~ is the expected excess return on asset i, conditional on information known to investors at the end of time period t. The unexpected return on asset i equals the sum of K factor realizations |Mathematical Expression Omitted~ times their betas or factor loadings ||Beta~.sub.ik~, plus an idiosyncratic error |Mathematical Expression Omitted~. We assume that |Mathematical Expression Omitted~, and |Mathematical Expression Omitted~. Here, the conditional expected excess return, |Mathematical Expression Omitted~, is allowed to vary over time according to investors' conditional information set at time t. …