Empirical Analysis of Credit Risk Regime Switching and Temporal Conditional Default Correlation in Credit Default Swap Valuation: The Market liquidity effect

In this paper, we extend the debate concerning Credit Default Swap valuation to include time varying correlation and co-variances. Traditional multi-variate techniques treat the correlations between covariates as constant over time; however, this view is not supported by the data. Secondly, since financial data does not follow a normal distribution because of its heavy tails, modeling the data using a Generalized Linear model (GLM) incorporating copulas emerge as a more robust technique over traditional approaches. This paper also includes an empirical analysis of the regime switching dynamics of credit risk in the presence of liquidity by following the general practice of assuming that credit and market risk follow a Markov process. The study was based on Credit Default Swap data obtained from Bloomberg that spanned the period January 1st 2004 to August 08th 2006. The empirical examination of the regime switching tendencies provided quantitative support to the anecdotal view that liquidity decreases as credit quality deteriorates. The analysis also examined the joint probability distribution of the credit risk determinants across credit quality through the use of a copula function which disaggregates the behavior embedded in the marginal gamma distributions, so as to isolate the level of dependence which is captured in the copula function. The results suggest that the time varying joint correlation matrix performed far superior as compared to the constant correlation matrix; the centerpiece of linear regression models.

The impact of mandatory versus voluntary auditor switches on stock liquidity: some Korean evidence

Using Korean listed firms subject to the auditor "designation rule", this paper shows that (1) firms that switch auditors exhibit lower stock liquidity than firms that do not switch auditors, and (2) the negative liquidity effect of auditor switches is concentrated in firms that switch to low-quality auditors. Meanwhile, firms that switch auditors under the auditor designation system do not exhibit lower stock liquidity, consistent with audit designation mitigating the concerns about audit quality deterioration around auditor changes. Furthermore, we find that foreign ownership has a mitigating impact on the negative relation between auditor switches and stock liquidity, suggesting that investors are less concerned about auditor switches when an alternative monitoring mechanism exists.

Trading activities and cross-sectional variation in stock expected return : evidence from Kuala Lumpur stock exchange

Trading activity has been considered as one of the possible factor that explains the cross-sectional variation in stock returns. In this study I use trading volume as a possible measure to proxy for liquidity as part of the trading activity. Monthly observations were used over a period 1995 to 2005 to examine the liquidity effect on stock expected returns. Based on findings it is appeared that level of liquidity does matter in explaining the expected stock returns in Malaysian capital market. While Fama-french factors also provide important explanation for stock returns. But none of the second moment variables proxying liquidity appeared to be statistically significant. However, momentum effect apprearently explain ing the cross-sectional variation in stock returns. 

Endangering of Businesses by the German Inheritance Tax? – An Empirical Analysis

This contribution addresses the substantial tax privilege for businesses introduced by the German Inheritance Tax Act 2009. Advocates of the vast or even entire tax exemption for businesses stress the potential damage of the inheritance tax on businesses, as those often lack liquidity to meet tax liability. This submission tackles this issue empirically based on data of the German Inheritance Tax Statistics and the SOEP. The results indicate that former German inheritance tax law has not endangered transferred businesses. Hence, there is no need for the tremendous tax privilege for businesses in current German inheritance tax law. An alternative flat inheritance tax without tax privileges, which meets revenue neutrality per tax class according to current tax law, provokes in some cases relative high tax loads which might trouble businesses.

Essays on the Effects of Social Insurance for Disability

This dissertation examines how social insurance, family support and work capacity enhance individuals' economic well-being following significant health and income shocks. I first examine the extent to which the liquidity-enhancing effects of Worker's Compensation (WC) benefits outweigh the moral hazard costs. Analyzing administrative data from Oregon, I estimate a hazard model exploiting variation in the timing and size of a retroactive lump-sum WC payment to decompose the elasticity of claim duration with respect to benefits into the elasticity with respect to an increase in cash on hand, and a decrease in the opportunity cost of missing work. I find that the liquidity effect accounts for 60 to 65 percent of the increase in claim duration among lower-wage workers, but less than half of the increase for higher earners. Using the framework from Chetty (2008), I conclude that the insurance value of WC exceeds the distortionary cost, and increasing the benefit level could increase social welfare. Next, I investigate how government-provided disability insurance (DI) interacts with private transfers to disabled individuals from their grown children. Using the Health and Retirement Study, I estimate a fixed effects, difference in differences regression to compare transfers between DI recipients and two control groups: rejected applicants and a reweighted sample of disabled non-applicants. I find that DI reduces the probability of receiving a transfer by no more than 3 percentage points, or 10 percent. Additional analysis reveals that DI could increase the probability of receiving a transfer in cases where children had limited prior information about the disability, suggesting that DI could send a welfare-improving information signal. Finally, Zachary Morris and I examine how a functional assessment could complement medical evaluations in determining eligibility for disability benefits and in targeting return to work interventions. We analyze claimants' self-reported functional capacity in a survey of current DI beneficiaries to estimate the share of disability claimants able to do work-related activity. We estimate that 13 percent of current DI beneficiaries are capable of work-related activity. Furthermore, other characteristics of these higher-functioning beneficiaries are positively correlated with employment, making them an appropriate target for return to work interventions.

A piaci likviditás hatása a vállalatokra (The effect of market liquidity for companies)

A 2007-ben kezdődő pénzügyi eredetű világgazdasági válság nyilvánvalóvá tette a kapcsolatot a likviditás két fajtája, a finanszírozási és a piaci likviditás között. A cikk megismertet a piaci likviditással kapcsolatos olyan alapvető fogalmakkal, mint order flow, ajánlati könyv, piaci struktúrák, bemutatja a piaci likviditás dimenzióit, a likviditás néhány mutatószámát és a piaci likviditás stilizált tényeit. A banki likviditáskezelés rövid összefoglalásán túl bevezetést nyújt a portfóliók likviditáskockázat melletti értékelésébe, végezetül összefoglalja, hogy az alapvetően finanszírozási likviditási kockázatnak kitett nem pénzügyi vállalatok hogyan vehetik figyelembe döntéseik meghozatalakor a piaci likviditást. _____________________ The global financial crisis starting in 2007 has showed that the connection between market liquidity and funding liquidity is apparent. This paper introduces the basic notions regarding market liquidity such as order flow, order book, and market structures. The article also presents the various dimensions of market liquidity, several measures of liquidity and the stylized facts of market liquidity. Besides a short description of liquidity management of banks it briefly introduces portfolio valuation in the presence of liquidity risk. Finally, the paper gives insight to non-financial companies, fundamentally exposed to funding liquidity risk, on how to consider market liquidity in their decisions.

Essays on volatility and liquidity in financial markets

The price formation of financial assets is a complex process. It extends beyond the standard economic paradigm of supply and demand to the understanding of the dynamic behavior of price variability, the price impact of information, and the implications of trading behavior of market participants on prices. In this thesis, I study aggregate market and individual assets volatility, liquidity dimensions, and causes of mispricing for US equities over a recent sample period. How volatility forecasts are modeled, what determines intradaily jumps and causes changes in intradaily volatility and what drives the premium of traded equity indexes? Are they induced, for example, by the information content of lagged volatility and return parameters or by macroeconomic news, changes in liquidity and volatility? Besides satisfying our intellectual curiosity, answers to these questions are of direct importance to investors developing trading strategies, policy makers evaluating macroeconomic policies and to arbitrageurs exploiting mispricing in exchange-traded funds. Results show that the leverage effect and lagged absolute returns improve forecasts of continuous components of daily realized volatility as well as jumps. Implied volatility does not subsume the information content of lagged returns in forecasting realized volatility and its components. The reported results are linked to the heterogeneous market hypothesis and demonstrate the validity of extending the hypothesis to returns. Depth shocks, signed order flow, the number of trades, and resiliency are the most important determinants of intradaily volatility. In contrast, spread shock and resiliency are predictive of signed intradaily jumps. There are fewer macroeconomic news announcement surprises that cause extreme price movements or jumps than those that elevate intradaily volatility. Finally, the premium of exchange-traded funds is significantly associated with momentum in net asset value and a number of liquidity parameters including the spread, traded volume, and illiquidity. The mispricing of industry exchange traded funds suggest that limits to arbitrage are driven by potential illiquidity.

Short-term Price Behavior and the Effect of Foreign Investors in Finnish Equity Markets (summary section only)

As globalization and capital free movement has increased, so has interest in the effects of that global money flow, especially during financial crises. The concern has been that large global money flows will affect the pricing of small local markets by causing, in particular, overreaction. The purpose of this thesis is to contribute to the body of work concerning short-term under- and overreaction and the short-term effects of foreign investment flow in the small Finnish equity markets. This thesis also compares foreign execution return to domestic execution return. This study’s results indicate that short-term under- and overreaction occurs in domestic-buy portfolios (domestic net buying) rather than in foreign-buy portfolios. This under- and overreaction, however, is not economically meaningful after controlling for the bid-ask bounce effect. Based on this finding, one can conclude that foreign investors do not have a destabilizing effect in the short-term in the Finnish markets. Foreign activity affects short-term returns. When foreign investors are net buyers (sellers) there are positive (negative) market adjusted returns. Literature related to nationality and institutional effect leads us to expect these kind of results. These foreign flows are persistent at a 5 % to 21 % level and the persistence of foreign buy flow is higher than the foreign sell flow. Foreign daily trading execution is worse than domestic execution. Literature which quantifies foreign investors as liquidity demanders and literature related to front-running leads us to expect poorer foreign execution than domestic execution.

Pricing of Liquidity Risks in London Stock Exchange

This thesis aims to investigate pricing of liquidity risks in London Stock Exchange. Liquidity Adjusted Capital Asset Pricing Model i.e. LCAPM developed by Acharya and Pedersen (2005) is being applied to test the influence of various liquidity risks on stock returns in London Stock Exchange. The Liquidity Adjusted Capital Asset Pricing model provides a unified framework for the testing of liquidity risks. All the common stocks listed and delisted for the period of 2000 to 2014 are included in the data sample. The study has incorporated three different measures of liquidity – Percent Quoted Spread, Amihud (2002) and Turnover. The reason behind the application of three different liquidity measures is the multi-dimensional nature of liquidity. Firm fixed effects panel regression is applied for the estimation of LCAPM. However, the results are robust according to Fama-Macbeth regressions. The results of the study indicates that liquidity risks in the form of (i) level of liquidity, (ii) commonality in liquidity (iii) flight to liquidity, (iv) depressed wealth effect and market return as well as aggregate liquidity risk are priced at London Stock Exchange. However, the results are sensitive to the choice of liquidity measures.

Liquidity, institutional ownership and regulation fair disclosure

There is a body of academic literature addressing two issues of importance for leveling the playing field for all classes of investors: 1) the impact of institutional investors on liquidity; and 2) the impact of Regulation Fair Disclosure on institutional investors and liquidity. Our study addresses both issues with the purpose of attaining a better understanding and explanation of this relationship. We classify institutional ownership according to Bushee's (1998, 2001) methodology; transient institutions, dedicated institutions and quasi-indexers. Our results indicate that while transient institutions and quasi-indexers have a positive impact on liquidity, dedicated institutional ownership is negatively associated with liquidity. This result is consistent with prior theoretical studies. We also find that the effectiveness ofthe Regulation Fair Disclosure in improving liquidity is limited to firms with higher transient institutional ownership, whereas quasi-indexed institutions have not been significantly affected by the regulations. In fact, the liquidity of firms is lower for firms with higher dedicated institutional holdings, which is evidence of the "chilling effect".

Volume-Synchronized Probability of Informed Trading (VPIN), Market Volatility, and High-Frequency Liquidity

We assess the predictive ability of three VPIN metrics on the basis of two highly volatile market events of China, and examine the association between VPIN and toxic-induced volatility through conditional probability analysis and multiple regression. We examine the dynamic relationship on VPIN and high-frequency liquidity using Vector Auto-Regression models, Granger Causality tests, and impulse response analysis. Our results suggest that Bulk Volume VPIN has the best risk-warning effect among major VPIN metrics. VPIN has a positive association with market volatility induced by toxic information flow. Most importantly, we document a positive feedback effect between VPIN and high-frequency liquidity, where a negative liquidity shock boosts up VPIN, which, in turn, leads to further liquidity drain. Our study provides empirical evidence that reflects an intrinsic game between informed traders and market makers when facing toxic information in the high-frequency trading world.

The Index Effect: an investigation of the price and volume effects surrounding changes to the S & P Australian indices

This paper examines the stock price and volume effects surrounding the announcement of constituent changes to the S&P/ASX 200 and four supplementary indices. Between April 2000 and December 2002 additions to (deletions from) the ASX 200 were associated with a significant price rise (fall) over the 10 day period following the market announcement of the change. Deletions were also associated with a significant fall on the announcement date itself These findings were corroborated by significant increases in trading volume over the same intervals, suggesting heavy trading activity by index funds in response to changes to the ASX 200. Following the implementation of these changes, both additions and deletions experienced a significant price reversion, supporting the price pressure hypothesis. By contrast, none of the supplementary indices displayed evidence of stock price or volume effects, which precludes the information and liquidity hypotheses as viable explanations for the findings of this research.

Call auction transparency and market liquidity: Evidence from China

This paper uses the natural experiment offered by the Shanghai Stock Exchange to investigate the impact of opening call auction transparency on market liquidity. We find that the dissemination of indicative trade information during the pre-open call auction session leads to an overall improvement in stock liquidity in the continuous trading session. Bid-ask spreads narrow in the first trading hour because adverse selection risk fell significantly and there is less price volatility in the continuous market. This effect is greater for actively traded securities than illiquid securities. Our findings are robust for different lengths of sample period, different lengths of trading hours after market open, and stocks that had (and had not) reformed the share split structure during our research period.

Does control-ownership divergence impair market liquidity in an emerging market? Evidence from China

This paper examines how institutional characteristics of emerging economies influence the effect of control-ownership divergence on market liquidity. We find that the divergence is negatively associated with liquidity and that this negative relationship is more pronounced in firms with more severe agency problems and information asymmetry. We argue that in an emerging market, the negative effect of the divergence on liquidity is worsened by state ownership and poorer shareholder protection, both of which result in more severe agency conflicts; we also find, however, that this effect is alleviated by the NTS reform, which aligns the interest of different shareholders.