Competitive Securities Market Research Articles

Fiscal Deficit, Government Debt and Interest Rate: An Empirical Analysis for Sri Lanka

The study attempts to examine the effect of fiscal deficit and government debt on interest rates in Sri Lanka over the period of 1977–2018 by using Unrestricted Vector Auto Regression (UVAR) Analysis. The results reveal that there is no significant effect of fiscal deficit and government debt on interest rates. The study suggests that minimizing the intervention in determining interest rates through administrative arrangements and other controls which were exercised in the past and adopting corrective measures to develop a competitive and diversified government securities market, facilitates to identify significant relationship among aforementioned variables as the theory explains. The study can be further developed by eliminating the existing limitations of insufficient time series data to reflect actual behavior of both short term and long-term interest rate structure of the government securities market in Sri Lanka.

Can Earnings Fixated Traders Hurt the Informativeness of the Asset Price in a Competitive Securities Market? Implications on Mark to Market Accounting

This paper examines the impact of earnings fixated traders on the asset price in a competitive securities market. In the market, there is a risky asset whose payoff is normally distributed. Earnings fixated traders underestimate the mean and variance of the asset payoff due to the fact that earnings fixated traders are functionally fixated on accounting earnings in formulating their trading strategies without paying attention to the accounting procedures used to generated those earnings numbers. This paper proves that the presence of earnings fixated traders does not affect the informativeness of the asset price. In addition, if the alternative accounting of mark-to-market replaces the conservative accounting, the results of this paper suggest that both the expected asset price and volatility of the asset price are higher but the informativeness of the asset price remains the same.

Accounting Conservatism and Asset Price

This paper presents a static model of a competitive securities market. In the market there are two assets: risk-free asset and risky asset. The payoff of the risk-free asset is one and the payoff of the risky asset is unknown. Rational traders correctly estimate the mean and variance of the risky asset payoff. Earnings fixated traders are functionally fixated on accounting earnings numbers. Due to the conservative accounting practices, earnings fixated traders underestimate the mean and variance of the risky asset payoff. Noise traders' demand for the risky asset is assumed to be random. This paper proves analytically that the presence of accounting conservatism decreases the asset price and the volatility of the asset price and it increases the expected return of the asset. In addition, this paper proves that the presence of accounting conservatism decreases the likelihood of the asset price lying on the right tail of its distribution and depending on the model parameter values, the presence of accounting conservatism may increase or decrease the likelihood of the asset price lying on the left tail of its distribution.

On the survival of earnings fixated traders in an informational environment

PurposeThe purpose of this paper is to examine the long-run survival of earnings fixated traders.Design/methodology/approachThis paper builds a theoretical model of a competitive securities market where both rational traders and earnings fixated traders receive an informational signal about the asset payoff before any trade occurs. Since earnings fixated traders underestimate the mean and variance of the risky asset payoff, earnings fixated traders is shown to make less expected profits than rational traders.FindingsIf traders’ types replicate according to the relative profitability of their trading strategies, then earnings fixated traders will disappear in the long run. The results of this paper provide analytical support to Tinic’s (1990) intuition about the eventual disappearance of earnings fixated traders.Research limitations/implicationsIn the literature, the underestimation of risk is popularly viewed as the cause of irrational traders being better able to exploit the misvaluations (created by noise traders) than rational traders. Hence, it favors the survival of irrational traders over rational traders. However, this paper disapproves this intuition in the informational environment of the competitive securities market.Practical implicationsThe market environment plays a crucial role in determining the long-run survival of irrational traders.Originality/valueThis paper is the first to present a theoretical result showing that in this informational environment of the competitive securities market, the underestimation of risk by irrational traders does not give them advantage over rational traders in exploiting the misvaluations (created by noise traders) as it does in Callen and Luo (2011) and Hirshleifer and Luo (2001).

The Role of Excess Liquid Assets in Monetary Policy of Small Open Developing Economies

The central bank in an open developing economy often balances the national foreign exchange market by selling liquid assets (typically domestic sovereign securities) to commercial banks and other institutional investors that would otherwise be motivated to invest in foreign financial assets. Therefore, securities denominated in domestic currency, ostensibly sold in the name of “mopping up excess reserves”, serve as a compensation transmission mechanism under which international reserves and the exchange rate target are central. This transmission mechanism allows the central bank to target the exchange rate while also pursuing an independent monetary policy under free capital mobility, thus to a large degree circumventing the Trilemma. In addition, the securities serve the other purpose of reducing the volatility of the portfolio of bank assets. In an imperfectly competitive security market, this compensation strategy is less expensive than would result if the strategy is to be implemented in a purely competitive securities market.

Book Reviews

Jianfeng Yu of the University of Minnesota and PBCSF, Tsinghua University reviews “Asset Price Response to New Information: The Effects of Conservatism Bias and Representativeness Heuristic”, by Guo Yin Luo. The Econlit abstract of this book begins: “Examines the role of conservatism bias and representativeness heuristic in determining asset price overreaction or underreaction to new information. Discusses conservatism bias and asset price overreaction or underreaction to new information in a competitive securities market; conservatism bias and asset price overreaction or underreaction to new information in the presence of strategic interaction; representativeness heuristic and asset price overreaction or underreaction to new information in a competitive securities market; representativeness heuristic and asset price overreaction or underreaction to new information in the presence of strategic interaction; and the presence of representativeness heuristic and conservatism bias in an asset market. Luo is in the DeGroote School of Business at McMaster University.”

The Representativeness Heuristic and Asset Price Reaction to New Information

In the existing literature, the representativeness heuristic is commonly viewed as a cause of asset price overreaction to new information. This article proves that the representativeness heuristic can cause asset price underreaction to new information in a competitive securities market. Specifically, there is one risk-free asset and one risky asset. Both rational and heuristic traders trade can against each other or against noise traders, whose demand is random. The payoff of the risky asset is unknown but all traders receive an informational signal about the risky asset’s payoff before any trading takes place. Due to the representativeness heuristic, the updated mean of the risky asset’s payoff for heuristic traders is higher (lower) than that for rational traders when the realization of the informational signal is above (below) the expected payoff of the risky asset. The results of this study suggest that regardless of noise traders being net buyers or sellers, the representativeness heuristic causes the asset price to overreact to new information close to the expected payoff of the risky asset and causes the asset price to underreact to new information far above or below the expected payoff of the risky asset. <b>TOPICS:</b>Statistical methods, risk management, in markets

Can representativeness heuristic traders survive in a competitive securities market?

The literature views aggressive trading behavior as the key for representativeness heuristic traders to survive in competition with rational traders. This paper provides another reason. That is, in this dynamic model of a competitive securities market, representativeness heuristic traders can derive more expected profit from the misvaluations (created by noise traders) than can rational traders. Consequently, the expected profit for heuristic traders can be bigger than that for rational traders. If traders' types replicate according to the profitability of the strategies, heuristic traders can survive or even drive out rational traders.

Representativeness Heuristic Can Cause Asset Price Underreaction to New Information in a Competitive Securities Market

In the literature, representativeness heuristic is commonly viewed as a cause of asset price overreaction to new information. This paper proves that representativeness heuristic can cause asset price under-reaction to new information in a competitive securities market. Specifically, there is one risk-free asset and one risky asset. Both rational and heuristic traders trade can against each other or against noise traders whose demand is random. The payoff of the risky asset is unknown but all traders receive an informational signal about the risky asset’s payoff before any trading takes place. Due to the representativeness heuristic, the updated mean of the risky asset’s payoff for heuristic traders is higher (lower) than that for rational traders when the realization of the informational signal is above (below) the expected payoff of the risky asset. The results of the paper suggest that regardless of noise traders being net buyers or sellers, the representativeness heuristic causes the asset price to overreact to new information close to the expected payoff of the risky asset and causes the asset price to underreact to new information far above or below the expected payoff of the risky asset.

On the survival of overconfident traders in a competitive securities market

Recent research has proposed several ways in which overconfident traders can persist in competition with rational traders. This paper offers an additional reason: overconfident traders do better than purely rational traders at exploiting mispricing caused by liquidity or noise traders. We examine both the static profitability of overconfident versus rational trading strategies, and the dynamic evolution of a population of overconfident, rational and noise traders. Replication of overconfident and rational types is assumed to be increasing in the recent profitability of their strategies. The main result is that the long-run steady-state equilibrium always involves overconfident traders as a substantial positive fraction of the population.

Financial Reporting and Auditing Under Alternative Damage Apportionment Rules

This article analyzes the impacts that three alternative damage apportionment rules have on an owner's financial-reporting decision, an auditor's audit-quality choice, and investors' pricing decisions within the context of a perfectly competitive securities market and owner solvency constraints. The strategic interactions between the players' strategies are analyzed within a setting where payoffs are endogenously determined and vary with the damage apportionment rule. These comparisons speak to potential changes resulting from the Private Securities Litigation Reform Act of 1995 which replaced joint-and-several liability with a proportionate liability rule. The main finding is that the audit failure rate can decrease when there is a switch from a joint-and-several to a proportional liability rule despite the fact that audit quality has also declined. This result occurs when there are strategic interactions between the owner's reporting strategy and the auditor's quality decision.