An Empirical Comparison of Linear and Nonlinear Volatility Models for Nordic Stock Returns

This paper examines how volatility in financial markets can preferable be modeled. The examination investigates how good the models for the volatility, both linear and nonlinear, are in absorbing skewness and kurtosis. The examination is done on the Nordic stock markets, including Finland, Sweden, Norway and Denmark. Different linear and nonlinear models are applied, and the results indicates that a linear model can almost always be used for modeling the series under investigation, even though nonlinear models performs slightly better in some cases. These results indicate that the markets under study are exposed to asymmetric patterns only to a certain degree. Negative shocks generally have a more prominent effect on the markets, but these effects are not really strong. However, in terms of absorbing skewness and kurtosis, nonlinear models outperform linear ones.

Performance Persistence of International Stock Funds

People saving in mutual funds often look at historical performance before they decide which funds to invest in. The implicit assumption made is that superior performance is likely to be repeated in the future. The findings presented in this study, which investigates funds sold on the Swedish market, support such an approach provided that the time horizons are limited to one year. International stock funds that have performed strongly one year are likely to outperform their peers also the following years. But if the historical and future time horizons are extended to two or three years, the positive relationship between past and future performance vanishes in most cases. Persistence tests focusing on the aggregated performance of fund companies were also carried out. These tests produced results rather similar to those on the individual fund level.

Technology-related peso problems in stock returns

Although empirical evidence suggests the contrary, many asset pricing models assume stock returns to be symmetrically distributed. In this paper it is argued that the occurrence of negative jumps in a firm's future earnings and, consequently, in its stock price, is positively related to the level of network externalities in the firm's product market. If the ex post frequency of these negative jumps in a sample does not equal the ex ante assessed probability of occurrence, the sample is subject to a peso problem. The hypothesis is tested for by regressing the skewness coefficient of a firm’s realised stock return distribution on the firm’s R&D intensity, i.e. the ratio of the firm’s research and development expenditure to its net sales. The empirical results support the technology-related peso problem hypothesis. In samples subject to such a peso problem, the returns are biased up and the variance is biased down.

The Influence of World Factors on Finnish Stock Market Volatility

This paper investigates to what extent the volatility of Finnish stock portfolios is transmitted through the "world volatility". We operationalize the volatility processes of Finnish leverage, industry, and size portfolio returns by asymmetric GARCH specifications according to Glosten et al. (1993). We use daily return data for January, 2, 1987 to December 30, 1998. We find that the world shock significantly enters the domestic models, and that the impact has increased over time. This applies also for the variance ratios, and the correlations to the world. The larger the firm, the larger is the world impact. The conditional variance is higher during recessions. The asymmetry parameter is surprisingly non-significant, and the leverage hypothesis cannot be verified. The return generating process of the domestic portfolio returns does usually not include the world information set, thus indicating that the returns are generated by a segmented conditional asset pricing model.

The Negative News Threshold - an Explanation for Negative Skewness in Stock Returns

A vast literature documents negative skewness and excess kurtosis in stock return distributions on several markets. We approach the issue of negative skewness from a different angle than in previous studies by suggesting a model, which we denote the “negative news threshold” hypothesis, that builds on asymmetrically distributed information and symmetric market responses. Our empirical tests reveal that returns for days when non-scheduled news are disclosed are the source of negative skewness in stock returns. This finding lends solid support to our model and suggests that negative skewness in stock returns is induced by asymmetries in the news disclosure policies of firm management.

The Pricing of American Put Options on Stock with Dividends

Pricing American put options on dividend-paying stocks has largely been ignored in the option pricing literature because the problem is mathematically complex and valuation usually resorts to computationally expensive and impractical pricing applications. This paper computed a simulation study, using two different approximation methods for the valuation of American put options on a stock with known discrete dividend payments. This to find out if there were pricing errors and to find out which could be the most usable method for practical users. The option pricing models used in the study was the dividend approximation by Blomeyer (1986) and the one by Barone-Adesi and Whaley (1988). The study showed that the approximation method by Blomeyer worked satisfactory for most situations, but some errors occur for longer times to the dividend payment, for smaller dividends and for in-the-money options. The approximation method by Barone-Adesi and Whaley worked well for in-the-money options and at-the-money options, but had serious pricing errors for out-of-the-money options. The conclusion of the study is that a combination of the both methods might be preferable to any single model.

Short-Horizon Asymmetric Mean-Reversion and Overreactions: Evidence from the Nordic Stock Markets

This paper examines the asymmetric behavior of conditional mean and variance. Short-horizon mean-reversion behavior in mean is modeled with an asymmetric nonlinear autoregressive model, and the variance is modeled with an Exponential GARCH in Mean model. The results of the empirical investigation of the Nordic stock markets indicates that negative returns revert faster to positive returns when positive returns generally persist longer. Asymmetry in both mean and variance can be seen on all included markets and are fairly similar. Volatility rises following negative returns more than following positive returns which is an indication of overreactions. Negative returns lead to increased variance and positive returns leads even to decreased variance.

Monetary Policy, Stock Price Misalignments and Macroeconomic Instability

Perhaps the most fundamental prediction of financial theory is that the expected returns on financial assets are determined by the amount of risk contained in their payoffs. Assets with a riskier payoff pattern should provide higher expected returns than assets that are otherwise similar but provide payoffs that contain less risk. Financial theory also predicts that not all types of risks should be compensated with higher expected returns. It is well-known that the asset-specific risk can be diversified away, whereas the systematic component of risk that affects all assets remains even in large portfolios. Thus, the asset-specific risk that the investor can easily get rid of by diversification should not lead to higher expected returns, and only the shared movement of individual asset returns – the sensitivity of these assets to a set of systematic risk factors – should matter for asset pricing. It is within this framework that this thesis is situated. The first essay proposes a new systematic risk factor, hypothesized to be correlated with changes in investor risk aversion, which manages to explain a large fraction of the return variation in the cross-section of stock returns. The second and third essays investigate the pricing of asset-specific risk, uncorrelated with commonly used risk factors, in the cross-section of stock returns. The three essays mentioned above use stock market data from the U.S. The fourth essay presents a new total return stock market index for the Finnish stock market beginning from the opening of the Helsinki Stock Exchange in 1912 and ending in 1969 when other total return indices become available. Because a total return stock market index for the period prior to 1970 has not been available before, academics and stock market participants have not known the historical return that stock market investors in Finland could have achieved on their investments. The new stock market index presented in essay 4 makes it possible, for the first time, to calculate the historical average return on the Finnish stock market and to conduct further studies that require long time-series of data.

Cobreaking of Stock Prices and Contagion

Financial crises have shown that dramatic movements in one financial market can have a powerful impact on other markets. The paper proposes to use cobreaking to model comovements between financial markets during crises and to test for conta-gion. It finds evidence of cobreaking between stock returns in developed markets. Finding cobreaking has implications for the diversification of international investments. For emerging mar-ket stock returns the evidence of cobreaking is mainly due to the non-financial event of the 9/11 terrorist attacks in 2001. Fi-nancial crises originating in one emerging market do not spread to other markets, i.e., no contagion.

The impact of stock option incentives on investment and firm value

This paper analyzes the relations among firm-level stock option portfolio incentives, investment, and firm value based on a sample of Finnish firms during the time period 1987 – 2000. Utilizing exact and complete information regarding stock option portfolio characteristics, we find some evidence that firm investment is increasing in the incentives to increase stock price (delta) and risk (vega). Furthermore, we find strong evidence of a positive relation between both incentive effects and firm value (Tobin’s Q). In contrast, when we allow for stock option incentives, investment, and firm value to be simultaneously determined, we find no evidence that investment is increasing in incentives. However, even after controlling for endogeneity, we find that both incentive effects arising from stock option compensation display a positive and significant effect on firm value. Finally, in contradiction to earlier findings, we observe that neither Tobin’s Q nor investment drives incentives.