European Equity Research Articles

Asymmetric Excitation and the US Bias in Portfolio Choice

We analyze a global equity return model driven by mutually exciting jump-diffusions with asymmetric excitation to account for the fact that crashes in the US get reflected quickly in other economies but much less the other way round. We solve in closed-form the associated portfolio optimization problem and find that the optimal portfolio is biased towards the US compared to classic models. By calibrating the model to historical returns on the US, Japanese, and European equity indices, we show that the over-exposure to the US equity predicted by our model is consistent with the cross-border equity portfolios observed in reality.

British-European Trade Relations and Brexit: An Empirical Analysis of the Impact of Economic and Financial Uncertainty on Exports

Brexit, the withdrawal of the United Kingdom (UK) from the European Union (EU), has led to significant exchange rate fluctuations and to uncertainty in financial markets and in UK–EU trade relations. In this article, we use a non-linear model to study how this uncertainty affects export companies. Exports tend to react in spurts when exchange rate fluctuations go beyond a band of inaction, referred to here as a “play area”. We apply an algorithm to study this hysteretic relationship with ordinary least squares (OLS) regressions. We examine the export relationship between Europe (Belgium, Germany, France, Italy, and The Netherlands) and the UK. To guarantee the robustness of the results, we estimate a variety of specifications for modeling economic uncertainty: (a) constant uncertainty, (b) exchange rate volatility, (c) volatility in European equity markets, (d) the Treasury Bill EuroDollar Difference (TED-spread), (e) the Economic Policy Uncertainty Index (EPUI), and (f) a combination of exchange rate volatility and the EPUI. Since the results show little evidence of hysteretic effects on British exports, we focus on the European side. The specifications including exchange rate and equity market volatility show a significant effect of hysteresis.

A regime switching skew-normal model of contagion

Abstract A flexible multivariate model of a time-varying joint distribution of asset returns is developed which allows for regime switching and a joint skew-normal distribution. A suite of tests for linear and nonlinear financial market contagion is developed within the framework. The model is illustrated through an application to contagion between US and European equity markets during the Global Financial Crisis. The results show that correlation contagion dominates coskewness contagion, but that coskewness contagion is significant for Greece. A flight to safety to the US is also evident in the significance of breaks in the skewness parameter in the crisis regime. Comparison to the Asian crisis shows that similar patterns emerge, with a flight to safety to Japan, and Malaysia affected by coskewnes contagion with Hong Kong.

Information Transmission across European Equity Markets During Crisis Periods

To respond to the market turmoil following the demise of Lehman Brothers in September 2008, the majority of European countries imposed short‐selling restrictions on their equity markets. Such a regulatory intervention is likely to have impact on the price formation process and information transmission between markets. We find that the long‐run cointegrating relation between the high‐ and low‐risk country groups in Europe broke down as the crisis emerged and the regulatory remedy failed to correct this. Furthermore, we find the information transmission between markets has reversed from the high‐risk to low‐risk markets in the period following the Lehman demise and imposition of the ban. Further, we notice a similar reversal in the spillover of both return and volatility processes between the different risk‐level country groups. We, therefore, conclude that, overall, the 2008 short‐selling ban had an adverse impact on information transmission between the identified country portfolios in both the long and short run. Notably, the ban did not restore the pre‐crisis transmission channels.

Editor’s Letter

1. Brian R. Bruce 1. Editor-in-Chief <!-- --> 1. To order reprints of this article, please contact David Rowe at d.rowe{at}pageantmedia.com or 646-891-2157. The Summer issue of the journal begins with an examination by Carlens and Higgins of the impact of MiFID II on European equity

MiFID II and Equity Market Liquidity, or There and Back Again

This article examines the impact of MiFID II on European equity market liquidity. MiFID II eliminated broker crossing networks, introduced caps on dark trading, and brought about new types of venues. The authors investigate the changes in the market in the lead-up to the January 3, 2018, implementation date and the early evidence supporting the expected liquidity shift toward block networks, periodic auctions, and systematic internalizers. Although all signs indicate limited change for end-investors, the delay in implementation of the double-volume caps means it is too early to fully assess the impact on trading costs. <b>TOPICS:</b>Exchanges/markets/clearinghouses, developed

Unconventional monetary policy announcements and risk aversion: evidence from the U.S. and European equity markets

ABSTRACTThis paper examines the role of unconventional monetary policy announcements on risk aversion – as proxied by the variance premium – by using panel data analysis. The objective of this empirical analysis is to investigate the risk-taking channel of monetary policy for the major European and U.S. equity markets by studying the impact that the announcements of an unconventional monetary policy has on market uncertainty and risk perception. By measuring the difference between risk-neutral and realised and conditional variance, we estimate the variance premium, which captures the impact that pricing concerns have on the prices of options. The empirical analysis indicates that easing monetary policies can significantly reduce the variance premium. In addition, we examine the risk premium structure across markets to determine the potential differences in investors’ risk aversion.

Network Structure and Market Risk in the European Equity Market

This paper proposes a methodology to anticipate market risk using qualitative and quantitative variables that capture communicative and financial activity within equity networks. During periods of crisis as market risk increases, companies tend to behave alike, and the number of news and common topics among companies increases. A corporate news network is built where the nodes are top European companies, and the edges are the number of news items on the same topic by every pair of companies identified by the topic model methodology. A longitudinal analysis was conducted using a time series of static social networks to generate a dynamic social network and proposed the component causality index as a leading indicator of market risk. This research finds out that the component causality index, based on centrality indicators, anticipates, or moves together with value-at-risk during the period 2005–2011.

Quantile dependence between the stock, bond and foreign exchange markets – Evidence from the UK

In the wake of Brexit, this paper aims to provide a measure for the quantile dependence amongst different financial assets – bond, stock, and currency – within the UK market and their cross-border linkages with the European equity market. We implement a nonparametric estimation method for both the tail and quantile dependence parameters on weekly data over the period 1989–2016 using copula. Our results suggest that the contagion effects between stock and currency markets are limited, even under extreme fluctuations. We also find a weak comovement between currency and bond markets, however, evidence of asymmetry is found in the dependence structure, possibly due to the ‘risk-reward’ scenario of international investors. Finally, our results indicate a weak dependence between stock returns and bond yields, possibly due to the low-yielding gilt and the thirst for income, pushing investors to diversify globally into other financial markets.

Brexit and Correlations of Equity Returns in France, Germany, Italy, Spain and the U.K.

This paper investigates whether the UK's referendum decision to leave the European Union (Brexit) had a positive impact on portfolio risk diversification. We estimate weekly dynamic conditional correlations between 1973 and 2018, and then optimal sectoral portfolio allocations over the same period. Our results show that correlations of equity returns increased as a consequence of economic integration among European countries from the mid-1980s until the late 2000s, and decreased in the UK after Black Wednesday and the Brexit referendum. We tested the existence of a correlation change-point on 27th June 2016 by applying Wied, Kraemer, and Dehling (2012)'s correlation structural break test, which we modified to account for dynamic conditional correlations. Application of this test confirms that the referendum date was a break-point in a third of UK manufacturing industries. The failure of Lehman Brothers and the 1987 stock market crash were also identified as structural breaks in equity correlations. Moreover, our findings suggest that the Brexit vote may constitute a long-term trend reversal of the convergence of equity return correlations in European markets, akin to Black Wednesday, rather than a shock like the 1987 and 2008 financial crises, which merely intensified the historical upward trend in correlations of European equity returns.

The Informational Role of Options Prices in China

The introduction of European style equity options in 2015 in China signaled a landmark moment in the development of its financial markets. We examine intraday implied volatility patterns and estimate the contribution of the Shanghai Stock Exchange (SSE) 50 ETF options to price discovery using the information leadership share (ILS) methodology. Notable differences are found in implied volatilities of puts and calls, consistent with the theory of event trading, while implied volatility patterns for each moneyness group contradict the crash-a-phobia phenomenon documented in previous studies. Furthermore, we find the options market dominates the price discovery process, with an average ILS of 67%. The price leadership evolves over time as investors use options to circumvent trading restrictions placed on the stock market.

The MiFIR Trading Obligation: Impact on Trading Volume and Liquidity

The new financial market regulation MiFID II/MiFIR will fundamentally change the trading and market infrastructure landscape in Europe. One key aspect is the trading obligation for shares that intends to restrict over-the-counter (OTC) trading to ensure that more trading takes place on regulated trading venues and on platforms of Systematic Internalisers (SIs). In this context, market observers often argue that SIs might have a competitive advantage due to the best execution concept in combination with the possible exemption of SIs from the tick size regime. Applying scenario analysis, we determine the likely migration of OTC trading volume to regulated trading venues and SIs. Based on our data set, covering intraday data including OTC trades as well as order book snapshots of EURO STOXX 50 constituents on major European venues, we investigate how changes in trading volume influence liquidity on lit markets. The results of our scenario analysis indicate that liquidity on lit markets might increase due to additional turnover formerly traded OTC. However, also a negative liquidity effect for lit markets and for the price discovery process is possible because of increased trading via SIs. According to this scenario, spreads might increase by 0.25%, round trip transaction costs of 50,000 € might increase by 0.92% and market depth 10 bps around the midpoint might decrease by 1.95% on lit venues. This effect on liquidity not only increases trading costs for investors in European equities trading, but also has a negative impact on issuers due to higher cost of capital and thereby on the real economy in Europe.

Aggregate Volatility Risk: International Evidence

Using a procedure analogous to that of Ang et al. (2006), this paper documents that aggregate volatility risk does not appear to be priced in European equity markets. Specifically, based on the 2002-2016 period (for which European stock return data is available), the price of aggregate volatility risk is not statistically different from zero. Analysis based on GARCH-class and high-frequency intraday data models support these results. Consequently, contrary to what has been reported in some studies that examine U.S. data, whether aggregate volatility risk is priced in equity markets is an open question.

Volatility Regime and Equity Portfolio Return: Evidence from Europe

This paper examines four European equity portfolios sorted by size, book-to-market (B/M) ratios, operating profitability, investment, and momentum by using Markov switching models with high and low volatility regimes. Our empirical analyses derive the following interesting findings. First, in four European equity portfolios, the smallest and the strongest momentum portfolio yields the highest return. In addition, the second smallest and the highest B/M portfolio, the second smallest and the highest operating profitability portfolio, and the second smallest and the second lowest investment portfolio also yield higher returns than the overall equity market in Europe. Further, our analyses using Markov switching models also reveal that for all the four European equity portfolios, the higher returns are obtained not in high volatility regimes but in low volatility regimes, and this evidence is against the assumption of risk-return trade off advocated in standard finance theory. Finally, our Markov switching analyses also suggest that for all the four European portfolios, staying probabilities in the same regimes are high and switching probabilities between two different regimes are generally low. In particular, staying probabilities in low volatility regimes are rather high, thus, all the four European equity portfolios yield high returns very stably by staying high return regimes.

Unraveling the Financial Contagion in European Stock Markets During Financial Crises: Multi-Timescale Analysis

ABSRACTThe article investigates the evidence of financial contagion and market integration in selected European equity markets during nine major crises across regions. The focus is to identify whether (i) contagion evidence is pure or fundamental and (ii) dynamic evolution of integration is in the short run or long run. Wavelet decomposition in both its discrete and continuous forms is used. The findings reveal the following: (i) prior to the subprime crisis, contagion effects generated short-term shocks. The most recent US subprime crisis, however, reveals the evidence of fundamental based contagion. (ii) We find increasing short-run and long-run stock market integration, driven by several stages of the establishment of Economic and Monetary Union (EMU), questioning the ultimate benefits of formal entry into EMU membership.

A return-based approach to identify home bias of European equity funds

ABSTRACTThis paper introduces a return-based approach to studying a possible home bias of European equity funds by estimating their exposures to their domestic markets. We first confirm the robustness of our approach using simulated portfolios with different proportions of domestic and foreign stocks. The empirical analysis examines equity funds domiciled in 15 European countries that invest in European stocks. We examine individual funds as well as portfolios comprising funds that are all domiciled in a particular country. Our findings reveal that the portfolios of four domiciles show a significant home bias. Moreover, we observe that in seven domiciles more than a quarter of the individual funds are home-biased. These results are robust when controlling for fund-specific benchmarks or for the average country exposures of all funds in our final sample. Finally, a home bias of individual funds is not related to superior performance, but actually results in higher investment risk consistent with underdiversification.

The performance of European equity carve-outs

In this paper we examine the valuation effects of equity carve-outs in Europe. We demonstrate that equity carve-out announcements yield significant abnormal returns for the shareholders of parent firms. This positive market reaction is stronger in countries that better protect minority shareholder rights. However, a remarkable price reversal is detected in the aftermath of a carve-out transaction that lasts up to two years. In contrast, parent-firm operating performance improves as long as the disposal of subsidiary assets is proven to be an optimal corporate decision. Subsidiaries stemming from the restructuring transaction also experience an initial positive market reaction which then reverses to severe price losses within a few months of the first day of listing.

Value Premium and Portfolio Return Regime: Evidence from European Equities

This paper examines the profitability of four European higher return stock portfolios and their linkages between the value premium factor return, high-minus-low (HML), developed by Fama and French. Our fundamental analyses and quantitative examinations using Markov switching models derive the following findings. First, in the four higher return stock portfolios in Europe, the smallest and the highest momentum portfolio shows the highest return. Second, the second smallest and the highest book-to-market (BM) portfolio, the second smallest and the highest operating profitability portfolio, and the second smallest and the second lowest investment portfolio for Europe also demonstrate higher excess returns than the overall stock market in Europe. Furthermore, we also clarify that for all the four European stock portfolios, there clearly exist two regimes: one is positively associated with the value premium factor return, HML, and the other is negatively associated with HML. We further reveal that recently, for all the four portfolios, the high value premium factor loading regimes shift to the other regimes that are uncorrelated with HML. This indicates that, in the recent periods, hedging and risk-diversification effects can be recognized in investing value stocks and the four higher return stock portfolios in Europe.

Equity crowdfunding inTechnology Transfer Strategies and Licensing

The main aim of this study is to investigate to what extent equity crowdfunding could enable firms to outsource research and development activities. Likewise, the present study aims at analysing the relationship between desorptive capacity (DCAP) and equity crowdfunding performance. We also aim at studying the mediation role of ICT firm's capabilities, connective capacity and minor equity ownership. In this regard, this study intends to pioneer into connecting the knowledge management theory with the crowdfunding studies. A sample of 180 projects based on the top ten European equity crowdfunding platforms has been used. Findings indicate that desorptive capacity enables companies in developing external knowledge retention and expoitation which, in turn, enhance equity crowdfunding performance.

Value relevance-evidence from food industry

The aim of the paper is to determine the correlation between the changes in the values of the selected analytical indicators, based on the financial statements and the change in the market value of companies, expressed through the value of the market value multipliers. The focus of research is on companies operating on the European markets within the food industry. The research methodology implies the use of regression analysis where the market multipliers of the selected enterprises will be set as dependent variables, and the analytical indicators are proposed as independent variables. The expected results should indicate the existence of value-relevant information in the financial statements of companies from food industry, which will serve all stakeholders for more efficient decision-making that is related to this industry sector. Data used in the research are acquired from European equity markets.