• Selected
• Entire List

Abstract:
There have been major advances in both theory and econometric techniques in mainstream macro-models and parallel advances in knowledge of the monetary transmission mechanism acting via asset prices. At the same time, behavioral finance has provided evidence that not all actors in the economy are fully rational and this has influenced models of asset pricing on which part of the monetary policy transmission mechanism depends. Such uncertainty about the behavior of asset prices has in part stimulated a move towards robustness, as an important criterion for guiding monetary policy. We argue that although we have discovered much, including what not to do, nevertheless our knowledge of the transmission mechanism is very incomplete. This is because, in spite of all the theoretical advances that have been made, there is still considerable uncertainty over the behavior of agents, which has been reinforced by insights from behavioral finance.

Abstract:
There have been major advances in both theory and econometric techniques in mainstream macro-models and parallel advances in knowledge of the monetary transmission mechanism acting via asset prices. At the same time, behavioral finance has provided evidence that not all actors in the economy are 'fully rational' and this has influenced models of asset pricing on which part of the monetary policy transmission mechanism depends. Such uncertainty about the behaviour of asset prices has in part stimulated a move towards 'robustness', as an important criterion for guiding monetary policy. We argue that although we have discovered much, including 'what not to do', nevertheless our knowledge of the transmission mechanism is very incomplete. This is because, in spite of all the theoretical advances that have been made, there is still considerable uncertainty over the behaviour of agents, which has been reinforced by insights from behavioral finance.

Monetary policy, behavioral finance, financial markets

Abstract:
This paper investigates the presence of nonlinear influences in the relationship between stock returns and the macroeconomy is examined for eight countries. The markets chosen are Belgium, Canada, France, Germany, Ireland, Japan, U.K. and the U.S. Specifically we analyse both the contemporaneous (asset pricing) relationship and the lagged (return predictability) relationship. Significantly the asset pricing relationship highlights the importance of accounting for variations in the relationships between bear markets and other states. Nonlinearity is accounted for via regime switching using a smooth transition regression (STR) model with the world market return as the transition variable. There is evidence of nonlinearity in all countries. Given the potentially complex nonlinearities in the determination of stock market prices, the possibility of multiple regimes (MRSTR) is also investigated. With the exception of Belgium, all markets exhibit evidence of multiple regimes. Results show that covariance with the world market portfolio increases during 'crisis' regimes, complementing the findings of Longin and Solnik (2001) and Ang, Chen and Xing (2004). Interest rate and inflation variables are strong determinants of stock returns while dividend yields and oil prices only influence returns in regimes identified by multiple regime models. Industrial production growth is not a significant factor. Out-of-sample forecasting of the nonlinear models is not superior to that of the linear models. However the smooth transition regression models predict direction more frequently than linear specifications. Analysis of return predictability produces results consistent with the standard stylised facts, i.e. that the dividend yield and term structure variables are important predictors of future stock returns.

Smooth transition, Regime switching

Abstract:
In this paper we analyse whether the consumption based capital asset pricing model is consistent with asset return data from the French and German stock markets. We evaluate the performance of the CCAPM by applying the non-parametric methodology of Hansen and Jagannathan (1991) and adopting alternative specifications of utility. The first specification assumes standard power utility, or time separable constant relative risk aversion (TS-CRRA) while the second allows for habit persistence (TNS-HP) and the final specification follows an Abel (1990) type model. We find that the model is consistent with the data. However, high degrees of risk aversion are implied for the models to be consistent. Incorporating habit persistence only partially reduces the implied levels of risk aversion.

Habit Persistence, Volatility Bounds, Risk Aversion, Sharpe Ratio

Abstract:
This paper examines the price impact of trading intensity on an emerging futures market. Utilizing a novel volume-augmented duration model of price discovery, the intensity effect is decomposed into liquidity and information components for the MexDer 28-day interest rate futures contract. We find that the duration between transactions exerts a positive influence on price changes. Increases in order flow and trade volume exert a positive and negative influence on price changes, respectively. The liquidity and information coefficients exhibit a contrasting effect on returns. The dominance of the liquidity component suggests that it is the liquidity traders who dictate the time to trade.

Emerging futures market, trading intensity, autoregressive conditional volume, autoregressive conditional duration

Abstract:
We systematically examine the comparative predictive performance of a number of linear and non-linear models for stock and bond returns in the G7 countries. Besides Markov switching, threshold autoregressive (TAR), and smooth transition autoregressive (STAR) regime switching models, we also estimate univariate models in which conditional heteroskedasticity is captured by a GARCH and in which predicted volatilities appear in the conditional mean function. Although we fail to find a consistent winner/out performer across all countries and markets, it turns out that capturing non-linear effects may be key to improve forecasting. U.S. and U.K. asset return data are "special" in the sense that good predictive performance seems to require that non-linear dynamics be modeled, especially using a Markov switching framework. Although occasionally stock and bond return forecasts for other G7 countries also appear to benefit from non-linear modeling (especially of TAR and STAR type), data from France, Germany, and Italy imply that the best predictive model is often one of the simple benchmarks, such as the random walk and univariate auto-regressions. U.S. and U.K. markets also provide the only data for which we find statistically significant differences between forecasting models. Results appear to be remarkably stable over time, robust to changes in the loss function used in statistical evaluations as well as to the methodology employed to perform pairwise comparisons.

Non-linearities, regime switching, threshold predictive regressions, forecasting, predictability in financial returns

Abstract:
This paper investigates the correlation dynamics in the equity markets of 13 Asia-Pacific countries, Europe and the US using the asymmetric dynamic conditional correlation GARCH model (AG-DCC-GARCH) introduced by Cappiello, Engle and Sheppard (2006). We find significant variation in correlation between markets through time. Stocks exhibit asymmetries in conditional correlations in addition to conditional volatility. Yet asymmetry is less apparent in less integrated markets. The Asian crisis acts as a structural break, with correlations increasing markedly between crisis countries during this period though the bear market in the early 2000s is a more significant event for correlations with developed markets. Our findings also provide further evidence consistent with increasing global market integration. The documented asymmetries and correlation dynamics have important implications for international portfolio diversification and asset allocation.

dynamic conditional correlation, asymmetry, international portfolio diversification

Abstract:
This study investigates the sensitivity of stock returns at the industry level to market, exchange rate and interest rate shocks in the four major European economies: France, Germany, Italy and the UK. In addition to exposure to the market, significant levels of exposure to both exchange rate risk, in the four countries, and interest rate risk, in France and Germany, are identified. Further, responses to sources of risk are decomposed into components attributable to news about future dividends, real interest rates and excess returns. All three sources of risk contain significant information about future cash flows and excess returns.

Exchange rate exposure, interest rate risk, stock returns

Abstract:
We use multivariate regime switching vector autoregressive models to characterize the time-varying linkages among the Irish stock market, one of the top world performers of the 1990s, and the US and UK stock markets. We find that two regimes, characterized as bear and bull states, are required to characterize the dynamics of excess equity returns both at the univariate and multivariate level. This implies that the regimes driving the small open economy stock market are largely synchronous with those typical of the major markets. However, despite the existence of a persistent bull state in which the correlations among Irish and UK and US excess returns are low, we find that state comovements involving the three markets are so relevant to reduce the optimal mean-variance weight carried by ISEQ stocks to at most one-quarter of the overall equity portfolio. We compute time-varying Sharpe ratios and recursive mean-variance portfolio weights and document that a regime switching framework produces out-of-sample portfolio performance that outperforms simpler models that ignore regimes. These results appear robust to endogenizing the effects of dynamics in spot exchange rates on excess stock returns.

international portfolio diversification, multivariate regime switching, national stock markets comovements, Sharpe ratios

Abstract:
In this paper we investigate the stock market response to international monetary policy changes in the UK and Germany. Specifically, we analyse the impact of (un)expected changes in UK and German/Euro area policy rates on UK and German aggregate and sectoral equity returns in an event study. The decomposition of (un)expected changes in policy rates are based on futures markets. Overall, our results suggest that, UK monetary policy surprises have a significant negative influence on both aggregate and industry level returns in both countries. The influence of German/Euro area monetary policy shocks appears insignificant for both Germany and the UK.

Monetary policy, stock market, interest rates

Abstract:
We use multivariate regime switching vector autoregressive models to characterize the time-varying linkages among short-term interest rates (monetary policy) and stock returns in the Irish, the US and UK markets. We find that two regimes, characterized as bear and bull states, are required to characterize the dynamics of returns and short-term rates. This implies that we cannot reject the hypothesis that the regimes driving the markets in the small open economy are largely synchronous with those typical of the major markets. We compute time-varying Sharpe ratios and recursive mean-variance portfolio weights and document that a regime switching framework produces out-of-sample portfolio performance that outperforms simpler models that ignore regimes. Interestingly, the portfolio shares derived under regime switching dynamics implies a fairly low committment to the Irish market, in spite of its brilliant unconditional risk-return trade-off.

multivariate regime switching; Sharpe ratio; time-varying predictability

Abstract:
We examine the influence of US and UK macroeconomic and financial variables on Irish stock returns in a nonlinear framework. We allow for time variation via regime switching using a smooth transition regression (STR) model. Importantly we find that both US and UK stock returns are significant determinants of Irish returns. Further, US returns are an important transition variable. Additionally, we show that both the US industrial production growth and changes in short term interest rates play an important role in explaining Irish stock returns. A two transition variable model finds that US short term interest rate changes exert a secondary nonlinear influence on Irish returns. The significance of US variables is reflective of the influence of US investment in the Irish economy.

Smooth transition, Regime switching

Abstract:
On an international post World War II dataset, we use an iterated GMM procedure to estimate and test the Campbell-Cochrane (1999) habit formation model. In addition, we analyze the predictive power of the surplus consumption ratio for future asset returns. We find that, although there are important cross-country differences, for the majority of countries in our sample the model gets empirical support in a variety of diffrent dimensions, including reasonable estimates of risk-free rates, and the model dominates the time-separable power utility model in terms of pricing errors. Further, for the majority of countries the surplus consumption ratio captures time-variation in expected returns. Together with the price-dividend ratio, the surplus consumption ratio contains significant information about future stock returns, also during the 1990s. Finally, in most countries the surplus consumption ratio is also a powerful predictor of future bond returns.

Habit formation, Campbell-Cochrane model, surplus consumption ratio, GMM estimation, pricing errors, return predictability

Abstract:
We analyse the ability of the consumption-based capital asset pricing model (C-CAPM) using traditional power utility, the recursive preferences model proposed by Epstein and Zin and two habit formation specifications proposed by Abel and Campbell and Cochrane to explain asset returns at both the economy level and, novelly, four individual sector groupings. We also investigate whether the models are capable of explaining the variation in the Fama-French factors. We find evidence supportive of both the habit formation specifications and the traditional power utility C-CAPM. The Epstein-Zin specification is clearly rejected. The preferred specification is that of Campbell and Cochrane. Importantly, parameter estimates for the sector groupings are consistent with theory, suggesting risk aversion is the same in all sectors. However, the ability of the models to describe the behaviour of the Fama-French factors is mixed.

Abstract:
We examine the influence of US, UK and German macroeconomic and financial variables on the stock returns of two relatively small, open European economies, Ireland and Denmark. Within a nonlinear framework, we allow for time variation via regime switching using a smooth transition regression (STR) model. We find that US (global) and UK and German (regional) stock returns are significant determinants of returns in both markets. Further, global information represented by oil and US asset price movements drive changes between states in each market. Significantly, the role of country-specific domestic variables is typically confined to a single state while global and regional variables pervade all states.

Abstract:
We measure and evaluate the performance of a number of Value-at-Risk (VaR) methods using a portfolio based on the foreign exchange exposure of a small open economy (Ireland) among its trading partners. The sample period highlights the changing nature of Ireland's exposure to risk over the past decade in the run-up to EMU. Our results offer an indication of the level of accuracy of the various approaches and discuss the issues of models ensuring statistical accuracy or more conservative leanings. Our findings suggest that the Orthogonal GARCH model is the most accurate methodology while the EWMA specification is the more conservative approach.

Value-at-Risk, foreign exchange, portfolio

Abstract:
We investigate the influence of changes in UK monetary policy on UK stock returns and the possible reasons behind such a response. Firstly, we conduct an event study to assess the impact of unexpected changes in monetary policy on aggregate and sectoral stock returns. The decomposition of unexpected changes in the policy rate is based on futures markets data. Secondly, using a variance decomposition in the spirit of Campbell (1991) we attempt to identity the channels behind the response of stock returns to monetary policy surprises. The variance decomposition results indicate that the monetary policy shock leads to a persistent negative response in terms of future excess returns for a number of sectors.