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Abstract:
An increase in correlation during turbulent market conditions implies a reduction in the benefits arising from portfolio diversification. Unfortunately, it is exactly then that these benefits are most needed. We investigate the robustness of recent empirical results that indicate correlation breakdown by deriving theoretical truncated and exceedance correlations using alternative distributional assumptions. Analytical results show that the empirical meltdown in diversification could be a result of assuming conditional normally distributed returns. When assuming a popular alternative distribution model - the bivariate Student-t distribution - we find significantly less support for diversification meltdown.

Exceedance correlation, Truncated correlation, Bivariate Student-t correlation

Abstract:
We revisit the role of default risk in asset pricing. The detail of our dataset allows us to undertake this analysis on a previously ignored segment of the market - microcap stocks, allegedly vulnerable to default risk. The cross-equation restrictions in our baseline models are rejected, but the risk premia are positive and statistically significant. When we allow for intertemporal risk premia, our findings remain significant. We also find that the estimated default premium increases over time. When we condition on the business cycle, we find that the default risk premium is twice as high during expansions than during contractions.

Default risk, Business cycle, Conditional Asset pricing, Microcaps

Abstract:
This study measures and analyzes the liquidity differences between Real Estate Investment Trusts (REITs) and other common stocks. The intraday variations documented in this study have implications for the appropriate timing of trades to minimize transaction costs and the substitutability of investments if illiquidity is priced. The findings reveal intraday patterns indicating lower liquidity for REITs than for common stocks when the liquidity measure is friction-based. In contrast, activity measures exhibit higher liquidity levels for REITs than for common stocks but this difference is only statistically significant at the beginning of the trading day. The findings also indicate that the ability to trade without influencing prices is 15%-25% greater for non-REITS compared to REITs, and the price of immediacy is 7% higher for REITs.

REIT, real estate investment trust, transaction cost, liquidity

Abstract:
We study the conditional probability of stock price reversals. The key conditioning variable is the level of margin required. We find that low margin levels are significantly related increased probability of price reversals.

stock, margin

Abstract:
A number of studies have provided evidence of increased correlation in global financial market returns during bear markets. Others, however, have shown that some of this evidence may have been biased. We derive an alternative estimator for implied correlation based on portfolio downside risk measures that does not suffer from this bias. These unbiased quantile correlation estimates are directly applicable to portfolio optimization and to risk management techniques in general. This simple and practical approach captures the increasing correlation in extreme market conditions while providing a pragmatic approach to understanding correlation structure in multivariate return distributions. Based on data for international equity markets we find evidence of significant increased correlation in extreme returns in international equity markets. This proves the importance of providing a tail adjusted mean-variance covariance matrix.

International equity markets, correlation, extreme returns, downside risk

Abstract:
In comparing trading platforms, most studies suggest that electronic systems lead price discovery, except perhaps in excessively volatile markets. A series of unusual events in 2006, sparking extreme volatility in natural gas futures trading, provide an ideal setting to revisit the resilience of trading system price leadership in the face of excessive volatility. We estimate time-varying Hasbrouck-style information shares to investigate the intertemporal and cross-sectional dynamics in price discovery. The results strongly suggest that the information share is time-dependent and contract-dependent. We find that the floor trading information share increases significantly with realized volatility.

price discovery, trading platforms, natural gas derivatives

Abstract:
Incomplete observations are a common feature of financial applications that use survey response, annual report, and proprietary banking and security issue and pricing data. Finance researchers use a variety of procedures, including deleting offending observations and imputing ad hoc values, that potentially fail to deliver efficient and unbiased parameter estimates. This article examines the application of a statistical framework, multiple imputation methods, that minimizes incomplete data problems if the missingness satisfies certain criteria. When applied to two financial datasets involving severe data incompleteness, the imputation methods outperform the ad hoc approaches commonly used in the finance literature.

incomplete data, multiple imputation

Abstract:
A number of studies have provided evidence of increased correlations in global financial market returns during bear markets. Other studies, however, have shown that some of this evidence may be biased. We derive an alternative to previous estimators for implied correlation that is based on measures of portfolio downside risk and that does not suffer from bias. The unbiased quantile correlation estimates are directly applicable to portfolio optimization and to risk management techniques in general. This simple and practical method captures the increasing correlation in extreme market conditions while providing a pragmatic approach to understanding correlation structure in multivariate return distributions. Based on data for international equity markets, we found evidence of significant increased correlation in international equity returns in bear markets. This finding proves the importance of providing a tail-adjusted mean-variance covariance matrix.

Abstract:
Benefits to portfolio diversification depend crucially on correct correlation estimates, hence it is of great importance to both risk management and portfolio optimisation that the exact nature of the correlation structure between international financial assets is understood. Recent discussion on the correlation of international equity returns has focussed on the issue of whether extreme movements in international financial markets are more highly correlated than usual returns. This implies a reduction in the benefits from portfolio diversification since extreme returns are more likely to occur with greater simultaneity. Using the Value-at-Risk methodology we are able to measure the quantile correlation structure implicit in international asset returns in a simple manner without having to resort to fully parametric modelling. We illustrate that the extraction of the quantile covariance structure from this quantile correlation structure is non-trivial. Using daily data on stock market indices for a variety of countries we observe how the correlation and covariance structure changes as we move into the tails of the return distribution. We find for extreme stock market movements the benefits to international diversification are significantly curtailed even after discarding spurious correlation changes.

Abstract:
This paper analyzes the dynamics of price formation for a strictly identical derivatives contract which is traded simultaneously at two competing exchanges. The domestic exchange is situated in the country that issues the underlying instrument. The foreign exchange offers a large international capital centre with many diversificationpossibilities. In addition, the exchanges are characterized by different trading systems. The domestic exchange operates by automated trading, the foreign exchange uses open outcry with an automated late afternoon session. We will investigate whether these differences support the trading system segmentation hypothesis. Our working hypothesis is two-fold. First, we investigate whether the transparency of each trading system affects quote setting. Second, we analyze whether the relative transparency of each market influences the lead/lag relationship between the two markets. Both hypotheses are empirically tested for the Bund futures contract as it is traded in London (LIFFE) and Frankfurt (DTB).

Abstract:
Index-futures arbitrageurs enter into the market only if the deviation from the arbitrage relation is large enough to compensate for transaction costs and associated interest-rate and dividend risks. Using a threshold autoregression model for the mispricing error, we estimate the band around the theoretical futures prices within which arbitrage is not profitable for most arbitrageurs. Combining these thresholds with an error correction model, we can make a distinction between the effects of arbitrageurs and infrequent trading on index and futures returns. The impact of the mispricing error on the returns is increasing with the magnitude of the mispricing error, and the effect of futures returns on index returns is significantly larger when the basis is negative.