Investment Volatility Research Articles

Do Trade Liberalisation and Financial Development Affect Macroeconomic Volatility? Evidence from Africa

The study investigates the effect of financial development and trade liberalisation on macroeconomic volatility in Africa between 1980 and 2017. The study employed panel data, de jure and de facto measures of financial openness and three estimation techniques (pooled Ordinary least square method [OLS], fixed effect and dynamic general method of moment [GMM]) to analyse the data. Results show that increased financial openness also leads to increased income volatility for the de jure measure of financial openness while for the de facto measure increased financial openness reduces income volatility. Results also show that financial openness leads to subtle volatility of output growth in Africa. The results contradict the argument that more financial openness leads to lower volatility in consumption in Africa. Furthermore, investment volatility responded to the measures of financial openness in different ways. The study conclude policymakers should focus more on policies that will foster financial system development as it has shown to be very effective in reducing macroeconomic volatility in Africa.

Optimal bailouts, bank’s incentive and risk

We show how the impact of a government bailout in the form of liquidity assistance on the ex ante effort of a representative bank depends on the volatility of its investment. The bank’s investment delivers a cashflow that follows a geometric Brownian motion and the government guarantees the bank’s liabilities. To counter the bank’s expectations of a bailout, the government may choose a tighter liquidity policy when the bank’s effort is not observable. This tighter liquidity induces more prudent ex ante behavior by the bank, but it may have the opposite effect when investment volatility is high. This novel effect arises because the bank could be discouraged to be prudent precisely because the chances of receiving liquidity assistance are low.

Tontine Bond Ladders

Tontines are useful vehicles for providing retirement income. Their payouts, however, will necessarily vary as a function of investment returns and the mortality experience of the membership pool. Retirees who place a high value on income stability will desire to minimize the variability of these payouts. This can be accomplished via a large membership pool to minimize the effect of mortality experience volatility and by using immunizing cash-flow matching techniques to minimize the effect of investment volatility. A structured bond ladder can achieve this quite effectively.

In Building Optimal Portfolios, Do Not Ignore Investors’ Emotions

The field of behavioural finance points out various investor biases and heuristics which inhibit optimal investment choices and are sometimes deemed irrational. Although emotions are often viewed as anathema to sound financial decisions, there is a big emotional component that has to be taken into consideration when holistically defining financial goals. Investors have differing goals for investing. Portfolio theory should therefore not overlook these goals and its horizon should be expanded to offer investors with the best possible achievable solution by incorporating financially efficient anxiety reduction. A rational solution should therefore take investors’ behavioural shortcoming into account because investors do not simply care about risk-adjusted returns but the best returns that can be achieved for the level of stress they are going to have to endure over the volatile investment journey.

Corporate Social Responsibility Disclosure, Financing Constraints and Investment-Cash Flow Sensitivity

Purpose - The purpose of this paper is to investigate the relationship between corporate social responsibility disclosure (CSRD) and investment-cash flow sensitivity, which is a surrogate for financing constraints. Research design, data, and methodology - Taking China's A-share listed companies between 2009 and 2016 as a sample, this paper empirically tests the relationship between CSRD and investment-cash flow sensitivity by Panel VAR model. By introducing the orthogonal impulse response function, this paper distinguishes the fundamental factors and financial ones that affect corporate investment behavior. Results - Findings indicate that: (1) investment-cash flow sensitivity of firms with low level of CSRD is significantly lower than that of firms with high level of CSRD; (2) the orthogonal impulse response of corporate investment to cash flow in firms with high level of CSRD is significantly different from zero, but it is not significant in firms with low level of CSRD; (3) for firms with low level of CSRD, 0.7% of corporate investment volatility can be explained by the change in cash flow, which is lower than that of firms with high level of CSRD (1.1%). Conclusions - Corporations disclosing more and higher quality CSRD are often those faced with financing constraints. Voluntary disclosure can help them alleviate information asymmetry and financing constraints.

Risk Weighting, Private Lending and Macroeconomic Dynamics

According to current regulation, European banks can apply zero risk weights to sovereign exposures in their balance sheet, irrespective of the assigned rating. We show that a zero risk weighting of sovereign bonds has implications by distorting banks' asset allocation decisions. Due to the lower regulatory cost of sovereign bonds, banks invest more in those bonds at the expense of lending to the real sector. To quantify the effect of this distortion, we build a standard RBC model featuring financial intermediation and a government sector calibrated to the euro area economy. Financial regulation is introduced via a penalty function that punishes banks if they deviate from the target capital ratio. We study the zero risk weight policy during normal times when there is no sovereign default risk and find that a policy introducing positive risk weights on government bonds has both long-run effects and stabilising properties with respect to the business cycle. This policy makes the steady state lending spread on loans to firms decline, stimulating investment and output. Also, it stabilises the lending spread, leading to a lower volatility of investment and output.

A Crypto Safe Haven Against Bitcoin

The design of Bitcoin is closely related to gold which has led to the idea that Bitcoin has gold-like features such as being a store of value and a safe haven. However, given Bitcoin's extreme volatility investors may rather need a safe haven against Bitcoin. We hypothesize that stablecoins provide such a safe haven and analyze high-frequency price changes of the largest stablecoins. We find that they act as safe havens, and Tether showing the strongest effect. The results demonstrate that Bitcoin investors seek out stablecoins when Bitcoin experiences extreme negative prices changes. Since stablecoins react to such price changes they are not stable at all times.

Political Uncertainty and Firm Investment: New Evidence from Chinese Listed Firms

Using hand-collected data on the turnover of mayor and party secretary in 260 Chinese cities, we study the effect of political uncertainty on firm investment. We find that political uncertainty has a negative impact on firm investment. Our baseline results show that firm investment declines when political leader is replaced and the effect of party secretary turnover on firm investment is stronger than that of mayor turnover. Our empirical analysis also demonstrates that: a) the frequency of political turnover is positively associated with the volatility of firm investment; b) state-owned firms significantly reduce investment when party secretary is replaced; c) firms invest less if the replacement of government officials is due to corruption. Lastly, our empirical results are robust to FE estimators and the exclusion of some influential observations.

Effectiveness of public investment on growth in sub-Saharan Africa

The aim of the paper is to explain why public investment may not be as effective as expected in promoting growth in some countries, especially in low-income countries of sub-Saharan Africa. Given the unquestionable importance of public investment for private capital accumulation and economic growth, this low effectiveness of public investment can lead to serious problems in economies, such as low-investment trap. In the literature, there are several different reasons given, such as the quality of institutions, as possible determinants of the productivity of public capital and investment. While controlling for other possible factors, this paper provides two new explanations for the low effectiveness of public investment: the threshold effect and the volatility effect of investment. It is proposed that public investment can effectively promote economic growth only if it is high (threshold effect) and stable (volatility effect) enough. In the paper, a simple growth model illustrates the possible impacts of the volatility and the level of public investment on economic growth. Empirical analysis then follows. The analysis covers the period of 1980–2014 and a large set of sub-Saharan countries where the negative consequences of the threshold and the volatility effects of public investment have been felt strongly. In order to identify the possible negative impacts of the high volatility and the low level of public investment on growth, the countries are first classified based on their income levels. In the empirical analysis, some indicators of the quality of governance, which are also expected to be important determinants of the effectiveness of public investment, are included to control for the impact of corruption. The empirical results indicate that public investment is indeed much lower in per capita terms as well as highly volatile in relatively low-income countries. For this group of countries, even though public investment is still a statistically significant determinant of economic development, it is relatively less effective in increasing economic growth. The economic impact of public investment on growth is much larger and highly significant for relatively middle- and high-income countries. The regression results provide a clear evidence that the effectiveness of public investment significantly declines when its per capita level is below a threshold. The findings also indicate that a higher volatility of public investment can lower growth rates significantly, especially in the low-income group where volatility is highest.

Capital Markets Integration and Economic Growth

Nowadays, the capital markets have an increasing role and weight in the modern financial systems. Economic (and financial) integration should allow companies to access more sophisticated and competitive capital markets for accelerating the economic development. The purpose of this paper is to investigate the impact of the capital markets’ integration on economic growth in the EU countries and identify the main factors through which capital markets’ development influences economic growth, especially in an economic (and monetary) union. In this article we had used the Autoregressive Distributed Lag model for the EU countries during 2004-2016. According to the results, we can say that the integration of capital markets has a positive impact on economic growth, and the main factors in which the capital market positively affects economic growth are stock market capitalization, capital mobility, value traded, stock indices, immigrants, and, to a greater extent, small, foreign portfolio investment. Policymakers in this area should pay attention reducing external debt, which is a significant proportion of foreign capital inflows, and encouraging the foreign portfolio investments to stimulate stock market development and growth, reducing extreme stock price volatility, fostering a good correlation of savings with investment (i.e. capital mobility), boosting volume growth transactions on stock markets, they should guarantee full employment through fiscal policy, monetary policy and trade policy as stated, by counteracting private sector or trade investment volatility, and reducing inequality, and stimulating increased labor mobility from developed countries to the least developed to balance the economy.

Modelling volatility persistence under stochasticity assumptions: evidence from common and alternative investments

Long-range memory estimation is a functional statistical mechanics technique to assess predictability in time series. In our work, we scrutinize the long-range dependence structure of volatility in a plethora of alternative and common investments via the use of a fractionally integrated conditional heteroscedastic model. Particularly, we evaluate the fractional persistence parameter of the temporal dynamics for the volatility series of Islamic, socially responsible and common investment indices related to the world major international stock markets. Long-range memory in volatility is measured under different types of market randomness, namely distributional specifications wherein the stochastic error components follow Normal and non-Normal densities. Our empirical results show strong evidence of long-range dependence in the volatility of alternative and common investments under all stochasticity assumptions. Furthermore, we show that the randomness profile has no effect upon the variability of long-range memory. We indicate differences in the statistical significance of the long-range memory across the investigated markets as well as in the degree of persistence. Our findings yield serious implications in terms of quantitative portfolio management and optimization.

The investment decision with technological and market uncertainties

ABSTRACTThis paper examines how technological uncertainty affects current investment; specifically, what is the impact on a firm’s investment in an existing technology when an improved technology might arrive in the future. The firm can invest in the current technology and upgrade to the new technology after its arrival (sequential investing), or it can bypass the current technology and invest directly in the new technology (leapfrogging). The main result is that, in the presence of market risk, future technological uncertainty has a non-monotonic effect on investment, with the investment trigger being a U-shaped function of the expected speed of arrival of the new technology. In this U-shaped relationship, the investment trigger starts rising later if the new technology is more attractive and also when volatility and interest rate are high and growth rate low; thus, technological uncertainty is more likely to have a positive effect on investment under these conditions. Finally, we apply the model to the sequential versus leapfrog investment decision, and find that leapfrogging becomes more attractive relative to sequential investment when interest rate and new technology earnings enhancement are higher, and when market volatility, growth rate and new technology investment cost are lower.

The Basic, Volatile, Sluggish and Stabilizing Forces in Aggregate Investment Behavior

The paper builds up a macro function of investment to capture various key determinants and explore the intricate determination mechanism of aggregate investment. It explicates the basic trend determinant of investment, locates the cause of investment volatility and identifies the magnifier of volatility, recognizes the sluggish force and its sluggish and metamorphosed effects on investment volatility, discovers the stabilizing forces by analyzing the dual effects between costs of capital and investment, and reconciles economic rationality with the long-established yet puzzling empirical findings that investment is strongly correlated with output while having little correlation with costs of capital. In striking contrast to the conventional literature, this paper uses a macro approach and finds out that the volatility of investment is mainly caused by changes in the change rate of consumption and the famous accelerator is not a volatile but stabilizing force.

Volatility - return paradigm of foreign private portfolio investment in Nigeria

The study aimed at capturing foreign private portfolio investment volatility as a determinant of its return. The study covered the periods between 1981 and 2013. An Exponential Generalized Autoregressive Conditional Heteroscedasticity (EGARCH) was specified and estimated using the maximum likelihood technique. The result reveals that foreign private portfolio investment volatility explains foreign private portfolio investment return. The result also revealed that good news has positive effect on foreign private portfolio returns while Momentum of risk in the system had profound effect on volatility. The EGARCH model significantly captures thick tailed returns and volatility clustering. News about volatility from previous period had no significant effect on current volatility. The persistence of volatility shocks were close to unity so that the shocks die out rather slowly. These outcomes suggest that investment selection should consider investment based on the dominance principle; negatively signed leverage term; lower momentum of risk; lesser shocks and innovation; less persistent volatility shock; and reasonable capacity to accommodate effects of ?non ? trading periods?, and accumulate predictable information releases or forecastable events at a higher rate?.?

Balance of Payment Dynamic in Indonesia and the Structure of Economy

This paper will assess in aggregate and detail the trend of BOP and its component in Indonesia. Stationarity test will be employed to each component of Indonesian BOP to assess the persistency. This study will calculate the balance of payment constrained growth (BOPC) using Kalman Filter technique (state space model). The BOP, secondary income, and financial account are found to be stationer which means that the data are mean reverting. On the other hand, current account balance, trade balance, service balance, primary income, and capital account balance are unit root. This paper found the evidence of the importance of commodity price to Indonesian current account and export. Indonesian dependency on commodity-based export need to be restructured. Indonesia should also consider the side effect of FDI as a source of financing for current account deficit, without ignoring the positive effect of FDI and the volatility of portfolio investment. The persistency of primary income deficit should also become Indonesian future policy agenda.

Returns and volatility of water investments

This study analyzes the stock returns and volatility of the global water industry in different (full, pre-GFC, GFC and post-GFC) periods. The study estimates ARMA (1, 1)-GARCH (1, 1) and EGARCH (1, 1) models on the World Water index (WOWAX), S-Network Global Water Index (S-Net), S&P Global Water Index (S&P), and MSCI ACWI Water Utilities Index (MSCI ACWI), the Asia, Europe, Latin America and US water markets, Pictet Global Water Fund (Pictet), and KBC Eco Water Fund (KBC Eco) for the period 2004–2014. In this study, the EGARCH (1, 1) model results suggest the existence of persistence of volatility from four water indices, four water markets and two water funds in different periods and asymmetric volatility (leverage) for Asia and US, S-Net and Pictet in full, pre-GFC and GFC periods and for WOWAX in GFC and post-GFC periods. The WOWAX is not highly correlated with water markets and water funds, which suggests that it may provide a possible opportunity for portfolio diversification in different periods.

Commodity booms and busts in emerging economies

Emerging economies, particularly those dependent on commodity exports, are prone to highly disruptive economic cycles. This paper proposes a small open economy model for a net commodity exporter to quantitatively study the triggers of these cycles. The economy consists of two sectors, one of which produces commodities with prices subject to exogenous international fluctuations. These fluctuations affect both the competitiveness of the economy and its borrowing terms, as higher commodity prices are associated with lower spreads between the country's borrowing rate and world interest rates. Both effects jointly result in strongly positive effects of commodity price increases on GDP, consumption, and investment, and a negative effect on the total trade balance. Furthermore, they generate excess volatility of consumption over output and a large volatility of investment. Besides explicitly incorporating a double role of commodity prices, the model structure nests the various candidate sources of shocks proposed in previous work on emerging economy business cycles. Estimating the model on Argentine data, we find that the contribution of commodity price shocks to fluctuations in post-1950 output growth is in the order of 38%. In addition, commodity prices account for around 42% and 61% of the variation in consumption and investment growth, respectively. We find transitory productivity shocks to be an important driver of output fluctuations, exceeding the contribution of shocks to the trend, which, though smaller, is not negligible.

Empirical Regularities of Nigeria’s Foreign Private Portfolio Investment Return and Volatility

ABSTRACT This paper examined the Empirical Regularities of Nigeria’s Foreign Private Portfolio Investment Return and Volatility. The study covered the periods between 1981 and 2014. An EGARCH model was specified. The analysis involves carrying out the tests for Financial Assets and Risk assumptions. The study revealed that Foreign Private Portfolio Investment Returns show Volatility clustering. Secondly, Foreign Private Portfolio Investment Return and Risk were found to have Thick tail. Variance Ratio Test [VRT] was used to test the weak form efficiency of the efficient market hypothesis and hence the non-predictability of financial markets. The Results showed that changes in one direction are more often followed by similar changes in either direction (volatility clustering). Given that Nigeria’s Foreign Private portfolio investment empirical imperatives is regular like that of the rest of the world, the paper thus recommends that investment decision models used by advanced analyst in developed countries can be applied to developing countries like Nigeria with little modification with respect to Foreign Private Portfolio Investment as their assets and risks display similar characteristics with assets and risks in developed countries.

The effect of longevity drift and investment volatility on income sufficiency in retirement

In 2014 the Government announced radical proposals which now allow people to withdraw money from their pension pot from age 55, ‘how they want, subject to their marginal rate of income tax in that year’. The main effect of this change will be to put more onus on the individual to make sure they have sufficient resources to last for their retirement, but it also removes the obligation to annuitise their funds at any future age. This paper is concerned with how people can best use their pension pots by aligning them to their personal financial objectives and longevity risks. It finds that for most people annuitising is not the best option, except for a few circumstances, and that draw down is preferable, especially where there is a bequest motive and the individual has assets such as property to fall back on. These options are low risk if simple rules are followed but they are not a substitute for professional advice and should only be used in conjunction.

Financial Structure and Macroeconomic Volatility: A Panel Data Analysis

In 2015, the European Commission (EC) launched its action plan for the creation of a European Capital Markets Union. The EC aims to return the European economy to sustainable growth and to enhance its shock absorbing capacity by reducing the reliance on bank finance and stimulating financial deepening and cross-border integration of Europe’s capital markets. Financial diversification and integrated European capital markets are expected to improve risk sharing among households, supporting economic stability. However, the economic literature reveals a lack of theoretical and empirical consensus on the superiority of either a bank-based or a market-based financial system in promoting growth or reducing macroeconomic volatility. This paper is the first to include bond markets in its financial structure indicators, besides stock markets and bank lending. Using panel data on 55 countries between 1975 and 2014 and three different measures of financial structure, we investigate the effect of the structure of the financial system on the volatility of output and investment growth as well as their cyclical components. We do not find evidence that market-based financial structures dampen volatility of output or overall investment. Increase of the stock market size relative to that of the banking sector has a significant positive effect on the business cycle volatility of investments.