Long-run Horizons Research Articles

Stock market volatility: Identifying major drivers and the nature of their impact

Abstract Financial-market risk, commonly measured in terms of asset-return volatility, plays a fundamental role in investment decisions, risk management and regulation. In this paper, we investigate a new modeling strategy that helps to better understand the forces that drive market risk. We use componentwise gradient boosting techniques to identify financial and macroeconomic factors influencing volatility and to assess the specific nature of their influence. Componentwise boosting is capable of producing parsimonious models from a, possibly, large number of predictors and—in contrast to other related techniques—allows a straightforward interpretation of the parameter estimates. Considering a wide range of potential risk drivers, we apply boosting to derive monthly volatility predictions for the equity market represented by S&P 500 index. Comparisons with commonly-used GARCH and EGARCH benchmark models show that our approach substantially improves out-of-sample volatility forecasts for short- and longer-run horizons. The results indicate that risk drivers affect future volatility in a nonlinear fashion.

Long-Run International Diversification

Prevailing wisdom in nance suggests long-run investors have a competitive advantage, since they can ride out short-run uctuations and mispricing, and pursue illiquid investments. This paper investigates if this advantage holds in a portfolio context, examining benets of international diversication across short- and longrun horizons. Employing a multi-horizon non-parametric lter, increased long-run correlations between international equity markets are detailed, even for synchronized markets. A model replicating the temporal aggregation properties of intermarket correlation is developed, indicating that short-run correlations are downward biased by frictions. Finally, the impact on portfolio allocation is investigated, demonstrating decreased risk reduction benets in the long-run.

Does gold glitter in the long-run? Gold as a hedge and safe haven across time and investment horizon

During times of market turmoil, investors often seek to mitigate risks associated with traditional investment assets such as equities and debt. The hedging and safe-haven properties of gold are examined in this paper for investors with short- and long-run horizons. Utilizing wavelet analysis, we find that gold acts as a hedge for a variety of international equity and debt markets for horizons of up to one year. The safe haven properties of gold during financial crises are further established, with gold shown to act as a safe haven for equity investors for long-run horizons of up to one year. However, during the economic contractions of the early 1980s gold is found not to act as a safe haven, displaying a positive relationship with equities across a range of horizons.

Inflation Targeting Does Not Anchor Inflation Expectations: Evidence from Firms in New Zealand

Using a new survey of firm managers, we investigate whether inflation expectations in New Zealand are anchored or not. In spite of 25 years of inflation targeting by the Reserve Bank of New Zealand, firm managers display little anchoring of such expectations. We document this finding along a number of dimensions. Managers are unaware of the identities of central bankers or of central banks’ objectives, and they are generally poorly informed about recent inflation dynamics. Their forecasts of future inflation reflect high levels of uncertainty and are extremely dispersed, and they are volatile along both short-run and long-run horizons. Similar results can be found for the United States using currently available surveys.

Short- and long-run rolling causality techniques and optimal window-wise lag selection: an application to the export-led growth hypothesis

The literature devoted to the export-led growth (ELG) hypothesis, which is of utmost importance for policymaking in emerging countries, provides mixed evidence for the validity of the hypothesis. Recent contributions focus on the time-dependence of the relationship between export and output growth using rolling causality techniques based on vector autoregressive models. These models focus on a short-term view which captures single policy-induced developments. However, long-term structural changes cannot be covered by examinations related to the short-term. This paper hence examines the time-varying validity of the ELG hypothesis for India for the period 1960–2011 using rolling causality techniques for both the short-run and long-run horizon. For the first time, window-wise optimal lag-selection procedures are applied in connection with these techniques. We find that exports long-run caused output growth from 1997 until 2009 which can be seen as a consequence of political reforms of the 1990s that boosted economic growth by generating foreign direct investment opportunities and higher exports. For the short-run, export significantly caused output in the period 1998–2003 which followed a concentration of liberalization measures in 1997. Causality in the reversed direction, from output to exports, only seems to be relevant in the short-run.

Can structural change explain the Meese-Rogoff puzzle?

This paper provides empirical evidence suggesting that fundamentals matter for stock price fluctuations once temporal instability underpinning stock price-relations is accounted for. Specifically, this study extends the out-of sample forecasting methodology of Meese and Rogoff (J Int Econ 14:3–24 (1983)) to the stock market after explicitly testing for parameter nonconstancy using recursive techniques. The predictive ability of a present value model based on Imperfect Knowledge Economics (IKE) is found to match that of the pure random walk benchmark at short forecasting horizons and to perform significantly better at medium to longer-run horizons based on conventional measures of predictability and direction of change statistics. In addition, the presence of a cointegrating relation is found only within regimes of statistical parameter constancy. Augmenting the MR methodology in a piecewise linear fashion yields empirical results in favor of a fundamentals-based account of stock price behavior overturning the recent results of Flood and Rose (2010).

Does Gold Glitter in the Long-Run? Gold as a Hedge and Safe Haven Across Time and Investment Horizon

During times of market turmoil, investors often seek to mitigate the risk associated with traditional investment assets such as equities and debt. The hedging, safe-haven and downside risk reduction properties of gold are examined in this paper for investors with short- and long-run horizons. Utilizing wavelet analysis, we find that gold acts as a short-run hedge for a variety of international equity and debt markets. The safe haven properties of gold during financial crises are further established, with gold shown to act as a safe haven for equity and debt investors across all horizons. Finally, gold is shown to reduce portfolio downside risk in the short-term but may actually contribute to increased long horizon downside risk during recessionary periods.

Long-Run Optimization Horizon, Durable Consumption Growth and Estimation of Risk Aversion

We present a durable consumption-based asset pricing model with Epstein-Zin preferences and the pricing kernel accommodating the long-run consumption risk. Consumption growth includes a small predictable component as in Bansal and Yaron (2004). The model is estimated with simple econometric techniques once we linearize it around a special case of the elasticity of inter- and intra-temporal substitution equal to one. After including the long-run consumption growth, the estimates of the model parameters become much more realistic and the fit closer to the data than for the case of the contemporaneous consumption growth. For example, the estimate of risk aversion falls from around 200 to 10, and the R2 increases from around 30% to 60%.

How Do Exchange Rates Move Following an Expansionary Monetary Policy?

This paper makes inquiries into the adjustment and evolution of the exchange rate towards its new long-run equilibrium level following a change in money supply. Joint and sequential effects of interest rate parities and sticky prices on the rise, from the short-term through to the long-run horizon, have been scrutinized. A pattern in exchange rate adjustments and movements has emerged that is featured by reverse movements of the exchange rate in the short-term, which is largely regulated by interest rate parities, prior to its eventual convergence to the new long-run equilibrium, which is confined to the working of PPP. Calibrations of the model with actual exchange rate data are performed in the study. Effects of recent quantitative easing exercises fit the featured pattern delicately well.

Foreign and Domestic Shocks: Macroeconomic Responses of ASEAN-3 Countries

The study provides new empirical evidence on the relative importance of foreign and domestic shocks on selected ASEAN-3 (Malaysia, Indonesia, and Thailand) macroeconomic variables. Three structural vector auto regression models are estimated for each country. The focal point is given on the formulation of the sources of foreign factors. The first model uses trade-weighted foreign variables of both US and Japan to represent the foreign factors. The other two models use US and Japan by themselves, respectively, to represent the foreign factors. Two important results are emerged. First, foreign sectors play an important role in influencing macroeconomic variables of each of the ASEAN-3 country, especially in the medium and the long-run horizon. Second, most of the time, the Japanese factors are more dominant than the US factors in influencing domestic output and inflation for each of the ASEAN-3 countries.

Stock Market Performance and Sustainable Economic Growth in Nigeria: A Bounds Testing Co-integration Approach

The study examined the relationship between stock market performance and economic growth in Nigeria. It utilized the bounds testing co-integration procedure also known as autoregressive distributed lag estimation procedure. The empirical model combined key stock market indicators and some traditional macroeconomic variables to estimate the hypothesized relationship in the study. It found that in the long-run, overall output in the Nigerian economy is less sensitive to changes in stock market capitalization as well as the average dividend yield thereby casting doubt on the ability of the Nigerian stock market in its present level of development to serve as a barometer for measuring or predicting the overall health of the Nigerian economy as well as its direction over the long-run horizon. The other major finding in the study is that the long-run growth of the Nigerian economy is highly sensitive to marginal variations in interest rate which is suggestive that macroeconomic variables in the country are at present more useful in shaping the long-run direction of the Nigerian economy.

The Short- And Long-Term Performance Of Privatization Initial Public Offerings In Europe

This article investigates the return behaviorof privatization initial public offerings (PIPOs) in Europe over both theshort- and long-run horizons. Using data from a sample of 162 PIPOs over theperiod 1986-2008, we show that European PIPOs outperform, in terms ofrisk-adjusted abnormal returns, a benchmark market index and a portfoliocomposed of 162 European private IPOs, regardless of the horizon of analysis.Our results are important for both investors and policymakers with respect totheir investment and privatization decisions, and also allow a betterunderstanding of the financial performance behavior of the privatizedstate-owned enterprises.

Can gold prices forecast the Australian dollar movements?

This paper explores whether gold prices have a reliable out-of-sample relationship with the Australian dollar/US dollar nominal and real exchange rates using daily and quarterly data, respectively, spanning the period 2000–2012. Through an Error Correction Model (ECM), the empirical findings suggest that the out-of-sample predictive ability is strong and robust across short- and long-run horizons. The results could offer informational availability for monetary policymakers, hedge fund managers and international portfolio managers. They also provide additional support to the hypothesis that both markets are driven by the same information sets.

Reverse shooting of exchange rates

Reverse shooting of the exchange rate has been put forward in this paper by scrutinizing the adjustment and evolution of the exchange rate towards its new long-run equilibrium level following a change in money supply. Joint and sequential effects of covered interest rate parity and the sticky price on the rise, from the short-term through the long-run horizon, results in a feature of reverse shooting of the exchange rate. Regardless of what the immediate response of the exchange rate to the change in money supply can be argued for, reverse shooting homogenizes the evolution path of exchange rate adjustment and movement from different views.

Transmisión de precios en los mercados regionales de ovino en España

The analysis of price relationships in commodity markets provides an approximate idea on markets performance as well as allows the researcher to analyze price responses to unanticipated shocks. The objective of this paper is to explore price relationships in geographical separated markets in the Spanish lamb sector. The methodology used is based on the specification of multivariate time series models which are flexible enough to take into account the stochastic properties of data, the multivariate nature of price relationships and to distinguish between short- and long-run horizons. Results indicate that lamb markets in Spain are strongly related being Zafra the leading market. The influence of Zafra is substantial in the southern markets while in the North, the Lonja del Ebro could be considered as the most representative market.

Long-Run Investment Horizons and Implications for Mixed-Asset Portfolio Allocations

When different asset classes display varying degrees of serial correlation, the investment horizon may substantially alter optimized mixed-asset portfolio allocations. Private-market assets (such as commercial real estate and private equity) often display much higher levels of autocorrelation than their public-market counterparts. Consequently, the one-year returns typically used in mixed-asset portfolio optimization procedures often generate excessive allocations to private-market asset classes. To counteract these excessive loadings, many researchers and practitioners advocate either ad hoc rules designed to constrain the maximum allocation to private-market vehicles and/or the use of some de-smoothing procedure to inject additional volatility in the observed return series. This paper takes a different approach by examining the three components in the standard portfolio optimization technique as the investment horizon lengthens; the auto-correlated nature of the observed returns of private-market assets implies that (annualized) long-horizon volatility decays less slowly – as compared to those public-market asset classes exhibiting the random walk – and long-horizon correlation (with most public-market alternatives) increases. In re-running the mixed-asset portfolio optimization with long-horizon returns, the allocations to commercial real estate – as one example of private-market assets – are much reduced and more consistent with allocation levels generally found in large institutional pension plans.

Future skills needs in EU and skills transferability in 2020: sector meta-analysis

Employment and its changes caused by restructuring are topics, which European Union pays attention to in longrun horizon, and the experience of current economic crisis confirms the rectitude of this approach. Structural changes always generate a need of the re-emplacement of laid off workers. Possibilities of their emplacement is strongly influenced by knowledge and skills offered by workers and demanded by employers. Acquaintance with future demand on knowledge and skills applicable across whole economy or applicable in different segments of labour market, i.e. in concrete occupations and sectors, enables effective targeting of educational activities at both individual and social levels, which will lead to higher flexibility of labour market mirrored mainly by high occupational mobility and low structural unemployment. The aim of this paper is to analyse future knowledge and skills needs recognized in 18 future-oriented sector analyses, published by European Commission in 2009, and identify knowledge and skills applicable in individual sectors, occupations and on the whole labour market, i.e. identify transferable knowledge and skills.

Alternative bvar models for forecasting inflation

This paper investigates the use of different priors to improve the inflation forecasting performance of BVAR models with Litterman’s prior. A Quasi-Bayesian method, with several different priors, is applied to a VAR model of simulated data as well as to the Australian economy from 1978:Q2 to 2006:Q4. A novel feature with this paper is the use of g-prior in the BVAR models to alleviate poor estimation of drift parameters of Traditional BVAR models. Some results are as follows: (1) In the Quasi-Bayesian framework, BVAR models with Normal-Wishart prior provide the most accurate forecasts of Australian inflation; (2) Generally in the parsimonious models, the BVAR with g-prior performs better than BVAR with Litterman’s prior; (3) In simulated data, the BVAR model with g-prior produces more accurate forecasts of driftless variable in the long-run horizons (first and second year forecast horizons).

Model uncertainty and asset return predictability: an application of Bayesian model averaging

We investigate model uncertainty associated with predictive regressions employed in asset return forecasting research. We use simple combination and Bayesian model averaging (BMA) techniques to compare the performance of these forecasting approaches in short-vs. long-run horizons of S&P500 monthly excess returns. Simple averaging involves an equally-weighted averaging of the forecasts from alternative combinations of factors used in the predictive regressions, whereas BMA involves computing the predictive probability that each model is the true model and uses these predictive probabilities as weights in combing the forecasts from different models. From a given set of multiple factors, we evaluate all possible pricing models to the extent, which they describe the data as dictated by the posterior model probabilities. We find that, while simple averaging compares quite favorably to forecasts derived from a random walk model with drift (using a 10-year out-of-sample iterative period), BMA outperforms simple averaging in longer compared to shorter forecast horizons. Moreover, we find further evidence of the latter when the predictive Bayesian model includes shorter, rather than longer lags of the predictive factors. An interesting outcome of this study tends to illustrate the power of BMA in suppressing model uncertainty through model as well as parameter shrinkage, especially when applied to longer predictive horizons.

Further evidence on the causal relationship between government spending and economic growth: The case of Greece, 1958–2004

The purpose of this paper is the empirical testing of the relationship between economic growth and government spending and, at the same time, to determine the extent to which economic growth causes growth in government expenditures (Wagner’s law) or the other way around (Keynesian hypothesis). The econometric analysis, using data for the Greek economy covering the period 1958–2004 and based on recent developments in the theory of cointegrated processes, reveals a long-run equilibrium relationship between government expenditures and economic output. Furthermore, the analysis detects causal effects in both the short-run and long-run horizon running from government expenditures to the level of economic activity and vice versa.