Multifactor Market Research Articles

Multifactor Market Indexes

This paper combines the CRSP market index with multiple factors to create a single multifactor market index. Empirical tests of different multifactor market indexes indicate that: (1) Sharpe ratios substantially increase and GRS test statistics decrease as multifactors are incrementally added to the CRSP index; and (2) the resultant multifactor market indexes are significantly priced in cross-sectional tests of associated beta loadings with t-values exceeding 3.0 in most cases.

Pension Fund Management, Investment Performance, and Herding in the Context of Regulatory Changes: New Evidence from the Polish Pension System

The aim of this paper is to assess the impact of reforms introduced in the operation of Polish open pension funds on management style, risk exposure and related investment performance. The article analyzes the impact of the reformed regulations on the herd behavior of fund managers. In particular, we examined whether the elimination of the internal benchmark for fund evaluation impacts the elimination or reduction of herd behavior. We proposed a multi-factor market model to evaluate the performance of funds investing in various types of instruments. Moreover, we used panel estimation to directly take into account the impact of the internal benchmark on herd behavior. Our results indicate that highly regulated funds may slightly outperform passive benchmarks and their unregulated competitors. In the case of Polish open pension funds, limiting investments in Treasury debt instruments clearly resulted in increased risk and volatility of returns. However, it also raised competition between funds and decreased the herd behavior. Additionally, the withdrawal of the mechanism evaluating funds based on the internal benchmark was also important in reducing herd behavior.

The Impact of EU Allowance Prices on the Stock Market Indices of the European Power Industries: Evidence From the Ongoing EU ETS Phase III

The European Union Emissions Trading Scheme (EU ETS) was created in 2005 to price every ton of carbon dioxide emissions. Within this framework, EU carbon dioxide emission allowances can affect electric power industry stock performance. This article uses a multifactor market model and a panel data econometric technique to investigate the long-run impact of EU carbon dioxide emission allowances on the European power sector. We also use panel cointegration to check whether there is a long-run relationship, and fully modified ordinary least square and dynamic ordinary least square to estimate any such relationship. The panel data include a daily sample for the ongoing EU ETS Phase III (from 1 January 2013 until 22 April 2017) and data from six European Union members (Austria, France, Germany, Italy, Netherlands, and Spain). The estimated coefficients suggest that EU allowance prices have a statistically significant and positive long-run effect on the European power sector stock market in EU ETS Phase III. This potentially supports EU efforts to toughen carbon reduction regime targets in order to remove the surplus from the system.

Further insights into the oil and equity market relationship

Purpose This paper aims to assess the asymmetric effects of oil price shocks and the impact of oil price volatility on the Eurozone’s supersector returns, with a particular emphasis on the impact of the subprime crisis and the euro debt crisis (EDC) on this relationship. Design/methodology/approach Empirical data consist of daily observations of the 19 EURO STOXX supersector indices and the Brent crude oil price index for the period January 2001 to August 2015. This paper uses a non-linear multifactor market model. This model accounts for heteroscedasticity and breakpoints that are identified by the Bai and Perron (1998, 2003) tests. Findings The results show that supersector returns are sensitive to oil price shocks. However, in most cases, their responsiveness to oil price volatility is not significant. The relationship between oil price shocks and supersector returns changes through time and depends on the sector. Financial turbulence affects the oil-stock market nexus. In most cases, the subprime crisis has had a positive impact on the oil-stock market relationship, whereas the EDC has had an overall negative effect. Before the subprime crisis, there is an evidence of asymmetric effects for some supersectors. Meanwhile, for most sectors, the asymmetric effects disappear after 2008. Originality/value The study improves understanding of the interaction between oil price risk and the Eurozone sector indices returns. Furthermore, it enables global investors to manage the risk inherent to the portfolio managers’ positions.

Stock Market Crisis Identification as a Factor Ensuring Country’s Economic Security

The article reviews the issues of the economic security of the country from the standpoint of identification of financial crises. The essence and content of a financial crisis are given, characteristic traits of a stock market bubble as an integral part of a stock market crisis are singled out. Special emphasis is laid on the study of the existing methods of identification and measurement of bubbles. The authors analyze the modern stock market crises, describe the Russian stock market vulnerability factors. The article evaluates the possibility for the origination of a stock market crisis in Russia on the modern stage resulting in the creation of a multi-factor stock market bubble identification model. The authors justify proposals and recommendations for the elimination of the existing Russian stock market problems aimed at removal of the economic security threats of the country.

The heterogeneous response of the stock market to emission allowance price: evidence from quantile regression

ABSTRACTThis paper investigates the effects of the European Union Emission Allowance (EUA)’s price on European carbon-intensive industries’ stock returns based on daily data from April 25, 2005 to July 24, 2017. Utilizing a multifactor market model specification and a panel quantile regression approach, the study tests whether the influences of the EUA price on the stock market are heterogeneous and asymmetric concerning each phase. The results show that a significant negative impact of the EUA price on the stock market is found in the middle- and high-return markets during Phases I and III, whereas in Phase II, the impacts are positive. Additionally, no asymmetric feature of the carbon market effect is shown in Phases I and III, but it shows a strong asymmetric effect across quantiles during Phase II. Some factors such as allocation rules and macroeconomic stability may cause this dissimilarity.

The impact of energy and agriculture prices on the stock performance of the water industry

Abstract Water issues are receiving increasing attention from policy-makers and international organizations due to water scarcity and global rising demand. Given that the demand for water is mainly driven by agriculture and energy, we use a multifactor market model to analyze the impact of agriculture and energy price trends on the price of listed companies operating in the water industry. Evidence highlights a sensitivity of water stocks returns to agriculture and energy price changes. Additionally, when using state space model to estimate dynamic beta coefficients, factor sensitivities show a time-varying behavior, especially during the 2008 economic and financial crisis.

Do Multi-Factors Proxy More Efficient Market Indexes?

A growing list of proposed factors is causing factor and model selection problems in asset pricing research and practice. This paper mitigates these problems by combining the CRSP market index with multiple factors to create a single multifactor market index. Empirical tests of multifactor market indexes using a variety of different test asset portfolios indicate that: (1) Sharpe ratios substantially increase and GRS test statistics decrease as multifactors are incrementally added to the CRSP index; and (2) the resultant multifactor market indexes are significantly priced in cross-sectional tests with t-values exceeding 3.0 in most cases. Further analyses create a new aggregate industry index which is priced among industry portfolios. When multifactors and industry portfolios are combined with the CRSP index, this more general multifactor market index boosts cross-sectional t-values and eliminates mispricing error. Lastly, momentum continues to be priced even when included in multifactor market indexes and therefore is a possible strong factor. Implications to developing more parsimonious asset pricing models as well as more efficient market indexes for investment purposes are discussed.

Defining Activeness: Active Share, Risk Share & Factor Share

This paper tackles a core question of portfolio management: How ‘active’ is an active portfolio? To answer this question holistically, we generalise the idea of Active Share by keeping the same calculation methodology but substituting in different types of portfolio and benchmark ‘weights’. In particular, we introduce the idea of Risk Share – based on asset risk contributions – and Factor Share – based on either factor style exposures or factor risk contributions. We describe these new metrics in a general multi-factor market framework and, using a set of simulated random portfolios of increasing activeness, explore some of the relationships between them and with other common fund performance measures. Finally, we conduct an empirical 'activeness' analysis on a set of South African equity funds. In both the simulated and empirical analyses, we find that the trio of Active Share, Risk Share and Factor Share provides one with a comprehensive, standardised means for easily assessing across multiple dimensions how a portfolio truly differs from its benchmark.

Oil price risk in the Eurozone: a sectoral analysis

This study investigates how oil price movements impact the main Eurozone industry supersectors returns. We use a multifactor market model in which we incorporate oil price changes as an additional risk factor. In order to account for possible breaks in the relationship, we use the Bai and Perron (1998, 2003) breakpoints identification methodology. We find evidence of the presence of structural instabilities on the relationship between sector stock returns and oil price changes. Different breakpoints are identified, particularly the 2003 Iraq invasion year, the 2008 subprime crisis and the 2012 Euro debt crisis. Moreover, our results prove that stock return sensitivities to oil prices are time varying and sector dependent. Besides, the subprime financial crisis appears to induce a significantly positive effect on the oil-stock market nexus. However, the Euro debt crisis has a mostly negative effect. The other identified breakpoints do not seem to have any significant effect on the oil stock market nexus.

The European Tourism Industry in Crisis: A Stock Market Perspective

This article aims to evaluate the market performance of the European tourism industry from 2004 to 2014, a period that includes the financial and economic crises, to highlight which macroeconomic factors influenced the industry stock returns. The Stoxx Europe 600 Travel & Leisure price index is used to proxy the industry stock performance, and a multifactor market model is employed to individuate which macroeconomic variables are able to drive tourism stock performance. Results highlight that tourism stock performance is influenced by market conditions and by uncertainty, measured through the Chicago Board Options Exchange Volatility index (VIX). Despite the importance of tourism in Europe and its contribution to the economic growth, there is scant evidence on the performance of this industry in this area and on its relationship with economic conditions. The article, to the best of knowledge, represents the first contribution on the performance of European tourism industry in crisis years with a macroeconomic perspective.

Fuel prices impacts on stock market of metallurgical industry under the EU emissions trading system

Metallurgical industry is among the largest industrial users of fossil fuels in the Spanish economy and it is one of the industries under the European Union emissions trading system. This study examines the long-run equilibrium relations and short-run interactions between fuels and European Union carbon emissions allowances price changes and the corporate value of Spanish iron and steel industry.From a multifactor market model specification, a cointegrated Vector Error Correction model is employed for the period covering 1st January 2013 to 15th September 2015 to embrace the analysis. Moreover, by using a panel data econometric approach, it is tested if the relationship of European Union carbon emissions allowances and fuel prices variations with stock returns are firm-specific.The results indicate a negative stable long-run relation between gas prices and stock market price changes of metallurgy sector and firm-specific effects. Regarding the EUA price change effect on aggregated stock market return, the VECM estimation did not find a significant long-run linkage. However, the results of EUA price change impact at firm level showed evidence for heterogeneity in this effect.

The Swap Market Model with Local Stochastic Volatility

The aim of this paper is to present the multi-factor swap market model with non-parametric local volatility functions and stochastic volatility scaling factors. We provide a Dupire-like formula with which calibration can be carried out with the particle algorithm in an efficient manner. We also discuss how the calibration method can be made applicable in the context of Libor Market Model. We show high accuracy of our calibration algorithm by numerical experiments.

Is socially responsible investment useful in Mexico? A multi-factor and ex-ante review

The present paper continues the firsts reviews made to socially responsible investment in Mexico. We extended these reviews by using a non-parametric multivariate equality test, along with a multi-factor market cap model, and a Monte Carlo simulation. Our results show that the IPCS index, the IPCcomp and the IPC have a statistically equal mean-variance performance, suggesting that this sort of investment style (SRI) is a good substitute of the broad market investment style in the long term. Among the causes of this finding is the fact that the IPCS and the IPCcomp indexes have almost the same large and small cap stock concentration and the IPC index (a large-cap one) is not as diversified and mean-variance efficient as the former.

How do Spanish polluting sectors' stock market returns react to European Union allowances prices? A panel data approach

This paper analyses whether and to what extent the EUA (European Union allowance) prices may be linked with Spanish polluting sectors' stock market returns.By utilizing a multifactor market model specification and panel data econometric approach, we test the if EUA price changes and stock returns of the Spanish sectors affected by EU ETS are correlated, the direction of this correlation and whether the carbon market effect is asymmetric and sector-specific. We use daily data for the full Phase II period and part of Phase III period of the EU ETS (from the 1st January 2008 to the 18th September 2015).A statistically significant positive and negative impact of EU ETS on stock market return is found for Phase II and III respectively. Additionally, EUA prices effect is shown to be sector-specific and there are different responses to increasing and decreasing carbon prices in sector-specific stock returns for both commitment periods.In contrast to others studies which refer to the first and/or earlier years of second EU ETS period and to a single sector (mainly power), our paper focuses on the second and the ongoing third period, and includes all polluting sectors encompassed under EU ETS.

Valuation of CMS range notes in a multifactor LIBOR market model

In the framework of a multifactor LIBOR market model (LMM), this paper presents a new approach for finding an approximate distribution of constant maturity swap (CMS) rates under the terminal martingale measure. With this approach, we derive an analytical pricing formula for CMS range notes, which is both intuitive and tractable. Many exotic CMS rate derivatives are widely traded in the marketplace or embedded in structure notes.

Measuring Risk Premiums Using Financial Reports and Actuarial Disclosures

Insurance companies increasingly augment their financial reports by releasing actuarial measures—the so-called embedded value—to supply information about the value of their life insurance activities. Both accounting and actuarial measures differ with respect to the timeliness of profit realisation and its reliability, and their performance in yielding information may differ. This paper asks if and how embedded values help in assessing risk premiums. We estimate multifactor market models in the spirit of Fama and French, and find that actuarial disclosures are superior to financial accounting in estimating these risk premiums. They further add information to financial reports as an estimator for growth opportunities.

Clean energy industries and rare earth materials: Economic and financial issues

In the last few years, rare earth materials (REM) prices have experienced a strong increase due to geopolitical and sustainability issues. Financial markets could already have factored in concerns about shortages of REM supplies into clean energy companies’ valuations. We use a multifactor market model for the period January 2006 to September 2012 to analyze the impact of REM price trends – specifically dysprosium and neodymium – on six clean energy indices (NYSE–BNEF) tracking the world's most important companies in the clean energy sector. The results show that during period of price increase, there is a negative relationships between REM price changes and the stock market performance of some clean energy indices. The European clean energy index is also negatively affected, and this effect could be relevant to policy makers, considering that Europe is implementing some relevant policy actions to support the development of the clean energy industry.

Estimating a Lévy multifactor market model for electricity futures markets by using independent component analysis

We develop an electricity market model for electricity futures and forwards contracts. The dynamic of these derivatives is modeled as a multifactor market model where the idea is to match the observed volatility term structure and correlation surface among different electricity futures deliveries. Empirical analysis shows that the distributions of electricity forward log returns are nonnormal. A Lévy multifactor model for electricity futures contracts with nonoverlapping delivery periods, in the particular case of the normal inverse Gaussian, is proposed in order to capture the heavy tails that are not described by the normal distribution. The large deviation from normality of electricity futures price returns produces an unbiased volatility estimation using principal component analysis. For this reason, in order to decompose the correlation/covariance matrix we consider the independent component analysis method, which can handle leptokurtic data. Having identified the K independent components that affect the forward term structure, we look at the time series of these components for jumps and fit a Lévy-type model for each principal component. Finally, we implement the model and provide some numerical examples using data from the European energy exchange and Powernext electricity market.

The impact of the EU ETS on the corporate value of European electricity corporations

In this research, the impact of the European Emission Trading Scheme (EU ETS) on the corporate value of European electricity corporations has been measured, and a comparison study of the impact between phase I and phase II of the EU ETS has been performed. To achieve this, a modified multifactor market model has been used to investigate how the development of EU emission allowance (EUA) prices has influenced corporate value. The results indicate that the impact of these has changed much from phase I to phase II. EUA price developments have affected corporate value in opposite directions: in phase I, the increase in EUA prices tended to cause corporate value appreciation, while during phase II, it was more likely to induce depreciation. Second, the corporate value development has been much more sensitive to changes in EUA prices in phase II than in phase I. The causes of the impact change have also been analyzed. The conclusion reached has been that the changes have resulted mainly from the adjustment of the EUA allocation policy between phases I and II. Moreover, the effects of corporate efforts to reduce CO2 emissions on corporate value did not emerge until phase II, when the EUA allocation became more rigorous.