Excess Volatility Research Articles

Monetary Policy and Homeownership: Empirical Evidence, Theory, and Policy Implications

We show that monetary policy affects homeownership decisions and argue that this effect is an important and overlooked channel of monetary policy transmission. We first document that monetary policy shocks are a substantial driver of fluctuations in the U.S. homeownership rate and that monetary policy affects households' housing tenure choices. We then develop and calibrate a two-agent New Keynesian model that can replicate the estimated transmission of monetary policy shocks to homeownership rates and housing rents. We find that the calibrated model provides an explanation to the "price puzzle" and delivers two important results with policy implications. First, the homeownership decision channel amplifies the redistributive effects of monetary policy, with contractionary shocks benefiting more outright homeowners and disadvantaging more renters and homeowners with a mortgage. Second, a monetary authority that reacts to a price index that includes housing rents generates excess house price, rents, and output volatility and larger real effects.

Out-of-equilibrium dynamics and excess volatility in firm networks

We study the conditions under which input-output networks can dynamically attain a competitive equilibrium, where markets clear and profits are zero. We endow a classical firm network model with minimal dynamical rules that reduce supply/demand imbalances and excess profits. We show that the time needed to reach equilibrium diverges to infinity as the system approaches an instability point beyond which the Hawkins-Simons condition is violated and competitive equilibrium is no longer admissible. We argue that such slow dynamics is a source of excess volatility, through accumulation and amplification of exogenous shocks. Factoring in essential physical constraints absent in our minimal model, such as causality or inventory management, we then propose a dynamically consistent model that displays a rich variety of phenomena. Competitive equilibrium can only be reached after some time and within some restricted region of parameter space, outside of which one observes spontaneous periodic and chaotic dynamics, reminiscent of real business cycles. This suggests an alternative explanation of excess volatility in terms of purely endogenous fluctuations. Diminishing return to scale and increased perishability of goods are found to ease convergence towards equilibrium.

Intermediation and price volatility

This paper analyzes the role of intermediaries in providing immediacy in fast markets. Fast markets are modelled as contests with the possibility of multiple winners where the probability of casting the best quote depends on prior technology investments. Depending on the market design, equilibrium pricing by intermediaries involves a trade-off, between monopolistic price distortion and excess volatility. Since equilibrium at the pricing stage generates an externality, investments into faster trading technologies are necessarily asymmetric in equilibrium, akin to markets with vertical product differentiation. Further, equilibrium is not necessarily efficient, since it is possible that a high-cost intermediary ends up investing excessively and thus trades more frequently than low-cost rivals.

Factors Affecting Changes in Broker Credit Directives in the Colombo Stock Exchange of Sri Lanka

Regulators use changes in market credit directives to control the potential destabilizing speculative behavior of investors and to inhibit excessive stock market volatility. This paper investigates macroeconomic and market factors associated with regulatory changes in broker credit directives in the Colombo Stock Exchange of Sri Lanka. We use a unique sample of changes in broker credit directives issued by the Securities and Exchange Commission of Sri Lanka during the high volatility period from 2010 to 2012 and employ a probit regression model to examine the factors affecting changes in such directives. We find that inflation, industrial production growth, trading volume, and market volatility significantly impact changes in broker credit directives. Although stock market returns and growth in broker credit volumes show no impact standing alone, they exert an important influence together. The SEC's regulatory actions on broker credit seem to be driven by market volatility, stock returns, and growth in broker credit volume.

The relationship between bitcoin and energy commodities: AutoRegressive distributed lag approach

The purpose of this paper is to study the relationship between bitcoin and energy commodities through the period of study from August 11, 2015 to March 31, 2018. For the econometric methodology, we utilize ARDL model, the cointegration relationship and the Granger Causality. From the empirical findings, we can observe that the presence of a short-term relationship between the variables with respect to the long-term relationship is significant and low. This result indicates the excessive volatility of bitcoin. The Granger causality test demonstrates the presence of unidirectional relationship between bitcoin and the variables representing energy and commodity products. Our paper contributes to the literature by applying for the first time many approaches together such as ARDL model, Granger Causality, Causality of Tada and Yamamoto, Cointegration relationship in short term and long term.

A New angle on excess consumption volatility in emerging countries: Does house price matter?

This paper focuses on house prices in order to explain excess consumption volatility, which is one of the stylized facts of the business cycle observed in emerging countries. The relative consumption volatility compared to output volatility is higher in emerging countries than in rich countries. Because house prices in emerging countries are more volatile than in advanced countries, this paper suggests a new angle focusing on relationship between house price fluctuation and excess consumption volatility. To begin, I construct a cross-country dataset, and suggest new evidence that house prices are more correlated with consumption in the case of emerging countries compared to rich countries while the correlation between house prices and output are similar between two country groups. Then, I build business cycle models given exogenous house price and output processes in order to explain excess consumption volatility puzzle. The results of the models suggest that high house price volatility in emerging countries causes their excess consumption volatility and that the mechanisms behind it are housing collateral effects and rental price pass-through. The former is related to the borrowing capacity affected by house price changes, and the latter is related to the link between house prices and housing consumption volatility.

Dual Banking System Stability Index in the Shadow of COVID-19 Pandemic

The financial system is categorized as stable if there is no excessive volatility from financial pressures or crises. The IMF indicates that the crisis is not only related to one element but more than two or three elements of the crisis. The banking system's stability is measured by the banking stability index, gauging the effectiveness of monetary policy and financial risk. This study aims to measure the stability of the Indonesian banking system in the dual banking system model. The indicator to measure banking stability used the Z-score statistic based on fluctuations of Return on Assets for each type of bank. The Markov Switching Vector Autoregressive (MSVAR) model method was used to analyze the volatility of banking stability. Independent variables used included credit risk (NPL), Loan to Deposit Ratio, Liquidity Risk, Net Interest Margin, Capital Adequacy Ratio, Money Market Rate, Inflation, Gross Domestic Product, Federal Reserve rate, and Exchange Rate. The results of the regime switch analysis concluded that Indonesia's banking stability experienced a structural break due to the effects of the pandemic in April 2020. Based on the average Z-score value, the Islamic banking stability index was higher than conventional banking. In other words, Islamic banking was more stable than the conventional banking system. The Islamic banking stability index (iZscore) was significantly influenced by the level of Net Operating Margin, Financing to deposit ratio, Potential Loss Profit Sharing, Islamic Money Market Rate, and Exchange Rate. However, non-performing financing did not affect Islamic banking stability since the profit-sharing system implemented by Islamic banking stability was more influenced by the ratio of potential loss and profit-sharing system.

Bounded rationality, adaptive behaviour, and asset prices

This paper develops a simple heterogeneous agent model (HAM) of asset prices with bounded rationality and adaptive behaviour. The model features feedback loop that amplifies shocks and leads to large price fluctuations. Our model not only retains the nonlinear interaction between prices and population in HAMs but also allows for a quantitative comparison with the data. Estimating the model to the data shows that the feedback loop helps explain the large variations in expected returns, such as return predictability and excess volatility.

Misperceptions of Bitcoin Volatility

Bitcoin market capitalization recently surpassed $1 trillion. While popular belief holds that a key characteristic of bitcoin is its excessive volatility, this article provides evidence that this is largely a misperception. We show that bitcoin return fluctuations are lower than those of roughly 900 stocks in the S&P1500 and 190 stocks in the S&P500. Moreover, we find that bitcoin is less volatile than commodities such as oil and silver, US Treasuries, AAA-rated corporate bonds, EU carbon credits, and some of the most popular technology and media stocks, including Apple, Twitter, and Netflix. Equally important, we find that during the March 2020 stock market crash triggered by COVID-19, the volatility of bitcoin was lower than that of most of these asset classes. The significant decline in bitcoin volatility over the past decade renders it more investable for conservative investors.

Pricing the Excess Volatility in Foreign Exchange Risk Premium and Forward Rate Bias

ABSTRACT We present the pricing of the documented excess volatility of the foreign exchange risk premium, relative to the interest rate differential. By specifying a term structure of interest rate model, the physical probability measure along with the pricing kernels or discount factors are used to derive a system for the expected future spot rate and the forward rate. The theoretical loads are found by solving the Riccati ordinary differential equations, and dynamic factors are captured to set up the global factors for both currencies. It shows that we prove the interest-rate surfaces are almost identical to the empirical ones, and the theoretical interest rates are guaranteed to be positive.

Sentiment, Mispricing and Excess Volatility in Presence of Institutional Investors

Sentiment, Mispricing and Excess Volatility in Presence of Institutional Investors

Carbon and safe-haven flows

<abstract> <p>This paper explores the role of European Union Allowances (EUAs) as a safe haven for a range of assets and analyses the effect of safe-haven flows on the European carbon futures market. In particular, we demonstrate that EUAs can be considered a refuge against fluctuations in corporate bonds, gold and volatility-related assets in periods of market turmoil. Furthermore, we have shown that extremely bearish and bullish movements in those assets for which the EUA acts as a safe haven induce excess volatility in carbon markets, higher carbon trading volume and larger than normal EUA bid-ask spreads. These findings support the idea that some traders, by considering carbon futures as a refuge asset, induce safe-haven flows into the carbon market. The presence of these flows provides additional insights into the financialisation of the European carbon futures market.</p> </abstract>

PECULIARITIES OF THE APPLICATION OF TECHNICAL AND FUNDAMENTAL ANALYSIS OF SECURITIES OF UKRAINIAN ISSUERS

Objective. The objective of the present article is to study the peculiarities of the functioning of the securities market of Ukraine, in particular its stock market sector, the outline of its main differences from the world stock markets, the determination of the peculiarities of the application of the tools of technical and fundamental analysis of securities to shares. Ukrainian issuers, as well as assess the state of the Ukrainian stock market in war conditions. Methods. The following methods were used during the research: the dialectical method of learning processes and phenomena (to analyze the peculiarities and state of development of the stock market of Ukraine); graphic (to display stock market index trends); methods of technical analysis (construction of MACD-histograms; construction of Price Oscillator (OSC); calculation of the relative strength index RSI) and fundamental analysis (multifactor forecasting of the share price); abstract-logical method (for forming the resulting research conclusions). Results. As a result of the study of the peculiarities of the functioning of the Ukrainian securities market, in particular its stock market sector, it was found that the volume of trading in shares and derivative stock derivatives accounts for less than 2% of transactions from the entire stock market of Ukraine, the greater part of which is spent on bond trading, mainly on operations with bonds of domestic government loans. A specific situation developed on the Ukrainian stock market after the war began: quotations of shares of Ukrainian issuers were suspended and both stock indices were "frozen". For almost six months, the Ukrainian stock market existed only as a government bond market, including a military bond market. Only from August 2022. quotations of shares of Ukrainian issuers on the Ukrainian Stock Exchange resumed. The volume of trade in bonds suffered a decrease due to the war, but not critically, but the volume of trade in shares of Ukrainian issuers decreased almost 5 times. Taking into account the specifics and characteristics of the securities market of Ukrainian issuers, it is most appropriate to use a combination of fundamental analysis and technical analysis approaches, but in the conditions of excessive volatility of the stock market during the war, the best results are provided by the methods of technical analysis. Multivariate predictive regression and autoregressive models were proposed to predict the BAVL share price.

A Theoretical Appraisal of Elaborating a Stock Market Prudential Surveillance System Based on a Conceptual Model of Integration of the Financial Sectors and Market Risk Mitigation

This theoretical research investigates the integration process between the two most prominent financial sectors the stock market and the credit market and attempts to engineer an alternative prudential toolkit shaped for stock market resilience from systemic risk and financial instability and that complements the basic Basel II and III framework shaped for the credit market. An analytical study will be conducted for the purpose of engineering a stock market prudential surveillance system with both micro and macro-prudential instruments, taking into account the integration constraints and unveiling thereby the threats ensuing from excessive covariance between stock returns. It finds evidence of theoretical arguments implying amplification and offsetting of threats by interaction between prudential instruments deployed simultaneously across sectors, for instance the credit sector and the stock market sector and finds solutions to collusion of interaction within the framework of elaborating instruments related to the prudential engineering. This research holds that Pareto improvement in the prevalence of market frictions introduced by prudential surveillance instruments leaves room for resilience from the onslaught of market risk entailed by sentiment driven speculation. Prudential surveillance fashioned like Basel II and III for the scope of mitigating stock market vulnerability to excessive volatility harbours some highly challengable presumptions regarding the methodology to be persued for the sake of shaping the best methodological approach to prudential engineering of instruments. The interaction process between the proposed prudential scheme and monetary policy highlights one additional challenging scope for central banking while shaping monetary policy stance. This complementary prudential framework reinvigorates the Basel II and III agreements which is specific to the credit sector and might reveal in shortage of instruments providing surveillance on the sources of systemic exposure whenever it is stemming from the stock market. This reinvigorating toolkit thereby reinforces the surveillance instruments aimed at mitigating financial instability in a more pervasive and comprehensive method.

Agent-based artificial financial market with evolutionary algorithm

In traditional financial studies, existing approaches are unable to address increasingly complex problems. In this paper, an artificial financial market is proposed, in accordance with the adaptation market hypothesis, using artificial intelligence algorithms. This market includes three types of agents with different investments and risk preferences, representing the heterogeneity of traders. Genetic network programming is combined with a state-action-reward-state-action (SARSA)(λ) algorithm for designing the market to reflect the adaptation of technical agents. A pricing mechanism is taken into consideration, based on the auction mechanism of the Chinese securities market. The characteristics of price time series are analyzed to determine whether excessive volatility exists in four different markets. Explanations are provided for the corresponding financial phenomena considering the hypotheses under the proposed novel artificial financial market.

The liquidity, performance and investor preference of socially responsible investments

PurposeThe purpose of the paper is to analyze socially responsible investment (SRI) asset performance compared to traditional assets using the MSCI KLD 400 Index. The authors examine the required return that investors expect to maintain their holdings in SRI stock and whether SRI stocks can be used for diversification during financial crises.Design/methodology/approachThe authors examine SRI stocks' liquidity from the MSCI KLD 400 index, encompassing all environmental, social and governance (ESG) factor investments over 25 years, from 1990 until 2019. The authors test whether sorting portfolios based on their excess return, liquidity and volatility can explain the difference in SRI and non-SRI stocks' returns and then examine the global financial crisis' (GFC) impact on excess returns for SRI and non-SRI assets.FindingsThe authors find a significant difference in liquidity and volatility between SRI and non-SRI stocks and that SRI stocks perform better during financial crises. The results suggest a possible general investor preference to invest in non-SRI stocks despite our findings that SRI stocks tend to withstand financial risk better than non-SRI stocks. The authors find that long-term investors may be willing to forego short-term gains to reduce their overall risk exposure during crises.Originality/valueSRI is gaining international popularity as an alternative investment that includes ratings based on ESG factors. Previous studies provide mixed results of whether SRI stocks outperform conventional stocks. In addition, there is limited research examining the liquidity and volatility of SRI assets. The authors compare the differences between SRI and non-SRI stocks in terms of excess return, volatility and liquidity and compare the liquidity of SRI and non-SRI stocks during the financial crisis.

Predicting future exchange rate changes based on interest rates and holding-period returns differentials net of the forward risk premium effects

One of the well-known puzzles in the empirical exchange rate literature is the forward premium anomaly; the interest rates differential between two countries predicts the opposite direction of their future exchange rate changes compared to the predictions of the uncovered interest rate parity (UIRP) under the rational expectations hypothesis (REH). In this paper, we show that the above puzzle can be attributed to the time-variation of the exchange rate risk premium (known as forward risk premium). This premium can also explain the failure of the holding-period returns differential to provide unbiased predictions of the future exchange rate changes. To control for the risk premium effects, in this paper we suggest a new forward premium regression framework adjusting the interest rates differential for these effects which are estimated by a two-country term structure model. We provide evidence that the suggested framework can predict the correct direction of the future exchange rate changes for a number of developed countries with liquid currencies. However, its predictive power is small due to excess volatility of the exchange rate changes.

Asset pricing with return extrapolation

We present a new model of asset prices in which a representative agent has extrapolative beliefs about stock market returns and Epstein-Zin preferences. The model quantitatively explains facts about asset prices, return expectations, and cash-flow expectations. When the agent’s beliefs about stock market returns are calibrated to survey expectations of investors, the model generates excess volatility and predictability of stock market returns, a high equity premium, a low and stable risk-free rate, and a low correlation between stock market returns and consumption growth. Moreover, the model has implications for expectations about future cash flows that are consistent with empirical findings.

Excess volatility pursuit in autoregressive GARCH model based panel data analysis at country level: BRICS context

PurposeThis particular study examined the government bond price variations in order to determine the presence of excess volatility both at country and panel group level of BRICS countries context.Design/methodology/approachThe study applied the autoregressive GARCH panel model approach proposed by Fakhry and Richter (2015) to evaluate the presence of excess volatility and then examined the diversification benefits. Further, the use of discrete wavelet transformation (DWT) has added the advantage to observe volatility across bonds along with potential diversification benefits by retaining information from the time and frequency domain perspective for both the maturities.FindingsThe main finding indicates that the excess volatility is present in BRICS countries at individual level i.e. in the case of Russia, India and China. However, the 10-year bond showing a less volatility compared to 5-year bond with the possibility of reaping out the benefits of diversification with international portfolio of sovereign bonds.Practical implicationsThe main implication of the research is related to the non-perseverance of EMH as far sovereign bonds of BRICS countries are concerned as the results indicate presence of excess volatility in the 5-year and 10-year bond markets. However, the implicit behavior of 5-year bond could benefit the active fund managers and investors by taking an advantage of a reducing systemic risk through short-medium term investments.Originality/valueThis study contributes not only to the existing studies of similar nature by examining the excess volatility in bond markets but also taking account of co-moment of distinct maturities to confirm possible international diversification benefits for BRICS countries context.

Informed speculation with k-level reasoning

This paper investigates the effect of strategic reasoning on financial markets with a level-k thinking framework. A level-k speculator performs k rounds of iterative reasoning to infer information from asset prices. In contrast to the static rational expectations equilibrium, the level-k framework produces a unified theory of momentum and contrarian trading strategies. Besides, this paper discusses how the distribution of sophistication levels affects several market variables and it sheds new light on empirical patterns such as: (1) overreaction of asset prices, (2) the excess volatility puzzle, and (3) the excessive trading volume puzzle. Moreover, this paper explores whether the level-k strategy converges to the rational expectations equilibrium.