European Equity Research Articles

Intraday Industry-Specific Spillover Effect in European Equity Markets

This paper investigates the existence of financial contagion between the US and 10 European stock markets. Using intraday minute per minute data of a large set of 374 equities from three different industries over the period from January to June 2011 we investigate the impact of increased volatility in the US on the cross-country industry level spillover effect. Self-built industry indices are used which allow implementing the same index methodology across different markets. We first show that spillover of asset price volatility from the US to European markets does exist; the greatest spike in the volatility in the target markets is observed in the first minute and absorbed in the first five minutes after the volatility increase. Second, we can state that Euro denominated markets amplify the spillover effect of volatility from the US market. Third, we provide evidence on the industry heterogeneity of the spillover effects and claim that an analysis of financial contagion across industries is desirable instead of the use of global market indices.

The Role of Fund Size in the Performance of Mutual Funds Assessed with DEA Models

This contribution studies the role of the size of mutual funds in the evaluation of the fund performance with a data envelopment analysis (DEA) approach, with the aim of studying the issue from different angles and with different statistical tools and of testing the presence of economies or diseconomies of scale in the mutual funds market. Firstly, we discuss the role of fund size in the performance evaluation and wonder whether it is appropriate to include size information among the variables of DEA models. Secondly, we analyse the presence of a relationship between the performance scores and the size of mutual funds using different statistical tests and carry out an empirical investigation on a set of European equity mutual funds.

European Equity Investing Through the Financial Crisis: Can Risk Parity, Momentum or Trend Following Help to Reduce Tail Risk?

A growing body of literature suggests that over widely varying historical eras and across a wide range of asset classes momentum investing, often accompanied by a trend following overlay, provides superior risk-adjusted returns. We examine the effectiveness of applying these methodologies to pan-European equity asset allocation through periods of potentially substantial market dislocation, in particular, with the advent of the single currency and the equity market crashes of the early 2000’s and 2008. With the introduction of the Euro there has been much discussion of the benefits of diversification via country based portfolios versus industry sector portfolios. Early studies simply looked at changing return correlations over time. The simple conclusion that increasing country correlations over time drives superior risk-adjusted portfolios towards diversification across sectors has been increasingly challenged. Our approach is different in that we apply momentum and trend following investing strategies and assess whether it is sectoral or country indices which dominate our portfolios through periods of structural changes and extreme volatility. Diversification via sectors is clearly the best strategy in times of equity market stress. In addition, the application of trend following offers a substantial improvement in risk-adjusted performance compared to traditional buy-and-hold portfolios. The terms momentum and trend following have often been used interchangeably although the former is a relative concept and the latter absolute. By combining the two we find that one can achieve the higher return levels associated with momentum portfolios but with much reduced volatility, tail risk and drawdowns due to trend following. We observe that a flexible asset allocation strategy that allocates capital to the best performing instruments irrespective of asset class enhances this further. Such methodologies offer superior risk adjusted returns, especially through periods of raised market volatility.

Correlation surprise

Soon after Harry Markowitz published his landmark 1952 article on portfolio selection, the correlation coefficient assumed vital significance as a measure of diversification and an input to portfolio construction. However, investors typically overlook the potential for correlation patterns to help predict subsequent return and risk. Kritzman and Li (2010) introduced what is perhaps the first measure to capture the degree of multivariate asset price ‘unusualness’ through time. Their financial turbulence score spikes when asset prices ‘behave in an uncharacteristic fashion, including extreme price moves, decoupling of correlated assets, and convergence of uncorrelated assets.’ We extend Kritzman and Li’s study by disentangling the volatility and correlation components of turbulence to derive a measure of correlation surprise. We show how correlation surprise is orthogonal to volatility and present empirical evidence that it contains incremental forward-looking information. On average, after controlling for volatility, we find that periods characterized by correlation surprise lead to higher risk and lower returns to risk premia than periods characterized by typical correlations. This result holds across many markets including US equities, European equities and foreign exchange. Our results corroborate the predictive capacity of turbulence and suggest that its decomposition may also prove fruitful in forecasting investment performance.

Asset allocation with risk factors

In this paper, we propose to build portfolios that offer diversification over so-called ‘risk factors’ and this within a minimum variance portfolio construction framework. We believe this approach is an important advancement compared with traditional asset allocation as it achieves a higher level of true risk diversification, taking into account the common and unique risk factors that each asset class is exposed to. We apply the methodology to a portfolio invested in European government bonds, corporate bonds, high-yield bonds and equity. The first application consists of an ex post factor risk contribution analysis where we decompose the portfolio risk into the risk associated with the economic activity, inflation, interest rate, exchange rate, credit risk, market risk and idiosyncratic asset class-specific risk factors. In the second application, we construct minimum variance portfolios that satisfy ex ante constraints on the factor risk contributions.

GeoExposure: Understanding European Managers’ Emerging Market Positioning

It is important for investors to assess both their direct and indirect exposures to geographical regions. Even if investment managers are constrained to stocks in the developed markets, they also may have significant exposure to other regions, including emerging markets. An analysis of a company’s revenue sources can help reveal indirect emerging market exposure. In this article, we analyze a universe of Large Cap European equity managers and, through a lens of EM revenue exposure, examine the size, value, forecast growth, and historical performance of their portfolios. We find that, for the period September 2008 through December 2012, managers separated into terciles by percent of EM revenue have noticeable differences in the aforementioned exposures and performance.

Selectivity and timing abilities of international socially responsible funds

This article analyses the selectivity and market timing abilities of international Socially Responsible Investment (SRI) funds, from eight European markets, in comparison to conventional funds with similar characteristics. The results show that differences in market timing abilities of international SRI funds and their conventional peers are not statistically significant. However, SRI funds investing in European equities are significantly worse stock pickers than conventional funds, whereas for funds investing globally, selectivity abilities are similar among both fund groups. Hence, our results suggest that a broader investment universe might increase SRI fund managers’ stock picking abilities and, consequently, improve SRI fund performance.

What the Shiller PE Says About Global Equity Markets: Update 2013

We update our analysis of expected returns for equity markets around the world. Based on the current Shiller-PE ratios of 38 developed and emerging equity markets around the world, our findings indicate that expected real returns are still positive for the coming five to ten years. European stock markets remain the most attractively valued, while the US stock market is among the most overvalued. We anticipate that expected real returns for US stocks over the coming five to ten years should be in the order of 2% to 2.5% per annum, while European equity markets may see real returns in the high single digits. At the same time, we note that rising interest rates could undercut expected returns.

Nobel Price for Father of the Efficient Market Hypothesis

Nobel Price for Father of the Efficient Market Hypothesis

Style and performance of international socially responsible funds in Europe

This paper analyses the performance and investment styles of internationally oriented Socially Responsible Investment (SRI) funds, domiciled in eight European markets, in comparison with characteristics-matched conventional funds. To the best of our knowledge, this is the first multi-country study, focused on international SRI funds (investing in Global and in European equities), to combine the matched-pairs approach with the use of robust conditional multi-factor performance evaluation models, which allow for both time-varying alphas and betas and also control for home biases and spurious regression biases.In general, the results show that differences in the performance of international SRI funds and their conventional peers are not statistically significant. Regarding investment styles, SRI and conventional funds exhibit similar factor exposures in most cases. In addition, conventional benchmarks present a higher explaining power of SRI fund returns than SRI benchmarks. Our results also show significant differences in the investment styles of SRI funds according to whether they use “best-in-class” screening strategies or not. When compared to SRI funds that employ simple negative and/or positive screens, SRI “best-in-class” funds present significantly lower exposures to small caps and momentum strategies and significantly higher exposures to local stocks.

European Equity Pairs Trading: The Effect of Data Frequency on Risk and Return

<p><em>This article examines an equity pairs trading strategy using daily, weekly and monthly European share price data over the period 1998 – 2007. The authors show that when stocks are matched into pairs with minimum distance between normalised historical prices, a simple trading rule based on volatility between these prices yields annualised raw returns of up to 15% for the weekly data frequency. Bootstrap results suggest returns from the strategy are attributable to skill rather than luck, while insignificant beta coefficients provide evidence that this is a market neutral strategy. Resistance of the strategy’s returns to reversal factors suggest pairs trading is fundamentally different to previously documented reversal strategies based on concepts such as mean reversion.</em><em></em></p>

Ownership Type Influence on Dividend Payments in CEE Countries

The present paper provides practical implications for the Central and Eastern European equity investors, who seek dividend income in addition to the capital appreciation. The insight into the dividend puzzle in the CEE companies, provided in the research, gives an overview of the dividend yields and payment stability as well as the relationship between the dividend payments and the type of ownership. Main findings of the study prove that the highest yield and the highest payout ratio are obtained in the case of strategic investor acting as a major shareholder (>10% of ownership capital). Binary logistic regression results provide the possibility to forecast whether the company will pay dividends. The typical dividend payer should not have family/management as a major investor, the ownership still should be concentrated and the investor preferably should be of local origin.

Euro Conversion and the Competition for Order Flow Among European Exchanges

We examine how euro conversion affected trading costs and volume in European equity markets. Euro conversion immediately changed tick sizes and price transparency, both of which could affect trading costs and relative trading volume. Longer-run, conversion could boost competition among exchanges. Using data from twelve European exchanges during 1998 and 1999 and the NYSE over the same period as a benchmark, we show that average trading costs decreased by 20% in Europe, and overall trading activity increased by 20%. Trading costs decreased or remained unchanged in all markets, but volume deteriorated in some markets and improved in others. These effects occurred on both euro and non-euro European exchanges. Our results are strongly consistent with the hypothesis that euro conversion boosted competition for order flow among the exchanges.

On the integration of European capital markets

PurposeThe paper aims to investigate European equity market integration by analyzing volatility spillover effects between selected indices of high liquidity from the major regulated European equity markets.Design/methodology/approachIn undertaking the empirical analysis, data for major European stock market indices were utilised. The conditional variance of the VAR‐GARCH model for each pair of indices is examined.FindingsThe results provide evidence on strong EU equity market integration. The findings in general suggest a high degree of European equity market interconnection. This situation is depicted through strong effects from one European equity market to the other, as well as through significant feedback effects between them.Originality/valueThe high level of interconnection found among the EU stock markets exerts significant influence on the efficient operation of each market and on asset and index pricing, which has therefore to be taken into account by investors and traders as market prices are set in common.

Momentum strategies of German mutual funds

The existence of the momentum effect in stock returns has been documented for the U.S. (e.g., Jegadeesh and Titman, 1993) and many other national equity markets worldwide (e.g., Griffin et al., 2003). However, little is known about the active employment of momentum strategies among institutional investors outside the U.S. In this respect, we provide first evidence of momentum behavior among German mutual funds.We find the fund trades to follow stock returns on an aggregated institutional level. Moreover, we detect significant momentum behavior among funds with a European and global equity focus, and among funds predominantly investing in Asia. In contrast, German funds do not seem to employ momentum strategies when trading domestic stocks. While only half of the funds across the entire sample trade in accordance with past returns, 66% of the funds within the largest size quintile follow momentum strategies. Finally, we do not find momentum trading funds to outperform the other funds.

Nonlinearity in cap-and-trade systems: The EUA price and its fundamentals

In this paper we examine the nonlinear relation between the EUA price and its fundamentals, such as energy prices, macroeconomic risk factors and weather conditions. By estimating a Markov regime-switching model, we find that the relation between the EUA price and its fundamentals varies over time. In particular, we are able to identify a low and a high volatility regime, both showing a strong impact of the fundamentals on the EUA price. The most important EUA price drivers are changes on the stock market and energy prices. The gas price and a broad European equity index affect the EUA price positively in both regimes, while the coal price and the oil price have a significant, but also positive impact only during the high and the low volatility regime, respectively. The high volatility regime is predominant in phases when economic activities are on a decrease or when institutional changes harm the confidence in the stringency of the EU ETS. This holds during the recession of 2008 and 2009, as well as during 2011 and 2012 when the debt crisis impaired the European economic outlook.

Stochastic Volatility Jump‐Diffusions for European Equity Index Dynamics

AbstractMajor research on equity index dynamics has investigated only US indices (usually the S&P 500) and has provided contradictory results. In this paper a clarification and extension of that previous research is given. We find that European equity indices have quite different dynamics from the S&P 500. Each of the European indices considered may be satisfactorily modelled using either an affine model with price and volatility jumps or a GARCH volatility process without jumps. The S&P 500 dynamics are much more difficult to capture in a jump‐diffusion framework.

Robust weak-form efficiency tests in volatile European equity indices

Robust weak-form efficiency tests are conducted to examine market efficiency in two pan-European indices: the large capitalization EuroStoxx 50 and the small capitalization EuroStoxx Small from January 2000 to March 2012. Application of the nonparametric Belaire-Franch and Opong (2005) multiple Variance Ratio (VR) test and Kim's (2006) wild bootstrap technique shows that large capitalization stocks display evidence of negative serial correlation in the recent time period, and these indices do generally have greater weak-form efficiency over longer time windows. This finding contrasts with Hung et al. (2009), particularly in large capitalization equities, and suggests that weak-form efficiency can be influenced by high market volatility.

Is there financial integration in the equity markets of the European Union?

Both casual observation and empirical research suggest that developed equity markets around the world, including the major European markets, are now highly integrated. Financial integration is a key goal of the European Union (EU) and was one motive for the adoption of the euro. In this article, we examine how far the process of financial integration has gone in the equity markets of the EU. We use an econometric methodology that permits us to measure the equity market convergence while allowing for a range of possible time paths, and for heterogeneity across countries. Our tests reject the hypothesis of overall convergence in the European equity markets. We do, however, find evidence of convergence within three distinct and economically meaningful subgroups of European markets. We find no evidence that the Euro has hastened equity market convergence amongst its members, above and beyond the broader global trends of lowered institutional and legal barriers and market liberalization.

A comparison between capitalization-weighted and equally weighted indexes in the European equity market

This article aims at comparing two major equity index construction methodologies, the capitalization-weighted and the equally weighted approaches. Focusing on the constituents of the DJ Euro Stoxx index from January 2002 to December 2011, it provides further evidence to add to the established literature on this topic, of the higher risk-adjusted returns achieved by equally weighted portfolios in comparison with cap-weighted indexes. The novelty of our study is that we test these findings on the Euro stock market by using four reweighting frequencies (monthly, quarterly, semiannually and annually) with the aim of identifying that which is most able to maximize the benefits of the contrarian strategy implicit in the equally weighted approach. Moreover, it is demonstrated that the excess returns are not driven solely by a ‘size effect’ that usually explains the difference in performance of the two methodologies. Finally, we confirm our results by performing a Fama-French (1992) three-factor regression analysis and also by using a portfolio approach based on the market capitalization of the index constituents. To evaluate the implementation of the EW strategy, from an operational perspective, we estimate the related transaction costs and show that trading costs are not able to affect the main results.