Institutional Algorithmic Trading, Statistical Arbitrage and Technical Analysis

Shen, Ning. 2009. Institutional Algorithmic Trading, Statistical Arbitrage And Technical Analysis. Doctoral Dissertation, Cornell University.

Technical analysis tools are widely used by short term investors in the financial market to identify trading opportunities and generate abnormal profit. Two of the most popular ones, Moving Average Convergence - Divergence and Bollinger Bands, are adopted in this study for algorithmic traders and statistical arbitragers (intraday trading) to reveal their effectiveness in terms of realizing sizeable profit before and after transaction cost. The simple oscillator signals derived from MACD and BB fail to efficiently recognize optimal trading timing and negative profit before and after transaction cost are realized under both strategies. Numerical analysis describes the sensitivity of profit with and without transaction fee to the strategies parameters. The results disclose that the selection of relevant parameters is not able to improve the performance of the strategies. A Long Only Filter Strategy (LOFS) is created to further investigate the possible strategies employed by institutional investors. Successfully generating considerable profit after transaction cost with a significant lower level risk, LOFS outperforms the buy-and-hold benchmark strategy as well as MACD and Bollinger Bands. LOFS is a promising strategy for statistical arbitragers who aim to profit from trading after accounting for transaction costs.

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Socially Responsible Investing: Morality, Religion And The Market From A Sociological Perspective

Peifer, Jared. 2011. Socially Responsible Investing: Morality, Religion And The Market From A Sociological Perspective. Doctoral Dissertation, Cornell University.

This study explores the intersection of religion and the economy by focusing on the case of socially responsible investing (SRI) mutual funds that are also religiously affiliated. Mutual fund managers and investors understandably want competitive return performance from their investments. Yet religious fund actors are also oriented toward avoiding ownership in "sin stocks" and/or trying to change the behavior of corporations that are held in investment portfolios. Meeting both monetary and moral objectives can be a challenge. In this study, I address two broad research questions. Firstly, how do social actors balance their moral commitments against their monetary interest? Through 29 semi-formal phone interviews with fund producers (or the employees) of Catholic, Muslim and Protestant religious mutual funds, I analyze their embedding and differentiating cultural work as they make sense of their involvement in the economic and religious spheres (Chapter 1). In a separate analysis, I conduct and analyze 41 phone interviews with investors of one religious fund family, Mennonite Mutual Aid (MMA) Praxis mutual funds. In particular, I compare the moral meaning respondents articulate for their charitable giving and their SR investing (Chapter 4). Secondly, I query whether the moral orientation of investors impacts their financial market behavior? Using data from the Center for Research in Security Prices (CRSP) from 1991 to 2007, I partition mutual funds into religious SRI, religious non-SRI and secular SRI and look for differences in levels of fund asset stability. This stability refers to fund flow volatility and the extent to which investors hold on to their fund shares with little regard to past return performance. Religious SRI assets are found to be the most stable fund category and I adjudicate whether the structural characteristics of religious groups or the moral orientation of religious investors best explains this empirical finding (Chapter 2). In a separate analysis, I analyze original phone survey data of MMA Praxis investors. This article's theoretical orientation focuses on moral and monetary "interest," defined as an individual level driving force. I find empirical evidence that moral interest induces fund commitment to SRI mutual funds, demonstrating that morality impacts behavior even in the financial market, a realm where monetary interest supposedly reigns. At the same time, I also find some evidence that monetary interest decreases fund commitment (Chapter 3).

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Sources Of Synergy In Mergers And Acquisitions

Kim, Jin Young. 2011. Sources Of Synergy In Mergers And Acquisitions. Doctoral Dissertation, Cornell University.

The general findings of the merger literature have raised the question of why mergers continue to be so prevalent when there is no conclusive evidence of value gains. In particular, the zero or even negative stock price reaction of the acquirer firm surrounding the announcement has been puzzling. In order to provide insight into this apparent contradiction, this study examines the sources and the realization of synergistic gains from mergers and acquisitions more directly. Prior studies on the sources of synergy have not been very effective since the nature of the data may have obscured the true economic impact of mergers. Using the rich information gained from the U.S. hotel industry data from 1991 to 2009, this study investigates the sources of merger-related gains while controlling for the market condition. Along the way, the much-neglected area of value erosion from M & A is also addressed. The findings indicate that at the hotel property level, both the target and the acquirer show significant cost savings; target hotel properties achieve price gains when they are merged into similar brand families of the acquirer; acquirer hotel properties gain occupancy improvements from the demand spillover from the target hotel properties. The study also finds that local market conflicts have a negative impact on the revenue of both target and acquirer properties. No evidence was found for price-increasing collusion among the properties of the target and the acquirer. The investigation of the offer premium and the operating performance shows that the offer premium is positively associated with synergistic gains for the acquirer properties while it is non-significant for the target properties. These results suggest an interesting possibility that the premium may actually be a price to gain control over the target's resources, which is critical to generating value on the acquirer side.

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A Wavelet-Based Analysis of Commodity Futures Markets

Power, Gabriel. 2007. A Wavelet-Based Analysis of Commodity Futures Markets. Doctoral Dissertation, Cornell University.

The time horizon of decision-making is an essential dimension of economic problems but is difficult to explicitly define. In this thesis, we use time series analysis augmented by wavelet transform methods to precisely identify distinct time horizons in economic data and measure their explanatory power. This enables us to address three timely and persistent questions in the literature on commodity derivatives markets are addressed. First, are findings of long memory (fractional integration) in commodity futures price volatility spurious, following Granger?s conjecture? Yes, only two out of eleven commodities are characterized by true long memory and certain stochastic break models (e.g. Markov-switching) are found to be more plausible. Second, do large Index Traders such as commodity pools and pension funds increase futures price volatility through a large volume of trading activity? This appears to be true only for non-storable commodity contracts. Third, can we improve the accuracy of term structure models of futures prices by (i) including more state variables to better capture maturity and inventory effects, and (ii) filtering out what appears to be noise at the shortest time horizons? The results suggest that (i) three state variables is an optimal choice and (ii) estimates using filtered data are not improved and the noise may be economically meaningful.

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Three Essays In Financial Globalization

Thongpruksa, Mingkwan. 2009. Three Essays In Financial Globalization. Doctoral Dissertation, Cornell University.

Financial globalization has many economic implications for countries. On one hand, it provides protection against national shocks and more efficient global allocation of resources. On the other hand, the financial inter linkage driven by globalization increases the exposure of countries to the financial and real shocks and to the risk of sudden capital reversals. This, in turn, has an impact on countries in various aspects. This dissertation explains the three different roles of financial globalization in individual countries and group of countries.

The first essay examines the degree of regional consumption risk sharing of countries in ASEAN+3 and investigates the extent to which financial integration determines the degree of regional consumption risk sharing. There are three main questions that this paper attempts to answer. First, the paper examines whether or not consumption risk sharing exists in ASEAN+3. Second, the paper explores to what directions they should contribute to the degree of regional consumption risk sharing. Finally, this paper examines to what extent ASEAN+3 shares the risk within the region vis-a-vis the rest of the world. According to the a empirical analysis, there is a limited degree of regional and bilateral risk sharing among ASEAN+3 and the degree of such has not changed much during 2000-2007. However, despite the limited degree of regional risk sharing, countries that invest in ASEAN+3 in moderate proportion, that is, Singapore, Korea, and Thailand, tend to have a higher degree of regional consumption risk sharing than global risk sharing.

The second essay addresses the major issues of inflation targeting in Thailand. An empirical study shows there is no evidence that inflation targeting has contributed to economic improvement since Thailand does not perform any better, and even worse in terms of output stability, than non inflation targeting countries. Moreover, the results show that exchange rate channel under the transmission mechanism plays a major role which contradicts the traditional inflation targeting, and thus does not fit Thailand's economy. In addition, SVAR indicates that the disinflation is accompanied by declined and volatility in output, suggesting that the adoption of inflation is not free from expenses. Regarding oil price surge, results obtained from SVAR estimation suggest that any active interest policy is able to help relieve the oil price shock and leaving other variables unaffected while having an impact of shorter duration than does inflation targeting.

The third essay presents an analysis of the interrelation between financial institutions and the housing sector in the United States. The evidence presented in the first and the second section of the essay suggests that all economic sectors have increasingly participated in financial investment and have been exposed to a higher degree of volatility in financial investment, combining with changes of regulations, and new available instruments, creating the unsustainable boom in U.S. housing markets during the late 1990s to early 2000s, and later resulted in the subprime crisis. The third section sheds light on the dynamics of house price by the panel error correction formulation. The econometric estimation shows the slow adjustment of housing prices towards long-run equilibrium. The last section examines the spillover effects of housing markets to other economic sectors. The estimated results from VECM indicates the strong and statistically significant of all channels of wealth effect, credit effect, and balance sheet effect.

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Roles Of Information In Corporate Mergers, Acquisitions And Investments

Simsir, Serif. 2009. Roles Of Information In Corporate Mergers, Acquisitions And Investments. Doctoral Dissertation, Cornell University.

The goal of this dissertation is to show how information asymmetries among market participants affect the way they operate in the financial markets. The first chapter investigates deal initiation in the context of mergers and acquisitions. We use Securities Exchange Commission (SEC) documents of the merging firms in our sample to discover which side (acquirer or target) initiated the deal. Our analysis indicates that target firms receive substantially lower premiums when they initiate the merger: abnormal returns to target firm stocks around the merger announcement date are 12 percentage points lower in such deals. When premiums are calculated over a longer time period, this difference increases to 27 percentage points. We argue that the information asymmetries between merging firms is the primary reason for this finding. Alternative explanations, such as financial distress and liquidity hypotheses, are considered as well. Our findings also relate to acquirer returns, synergy gains from mergers, characteristics of firms involved in buyer- and seller-initiated deals and the effect of the Sarbanes-Oxley Act on premium differences across initiation groups. The second chapter examines how information asymmetries within the set of outside investors influence the investment and financing decisions of firms. In our model, some investors have access to private level information which is not publicly available to others. We show that this external information asymmetry systematically influences the equilibrium stock price, which in turn affects firm's payoff from equity financing. In particular, firms are better off with equity financing when the information asymmetry among the set of outside investors is low. In the third chapter, we analyze past stock returns of the merging firms, and examine their role in explaining abnormal returns around the announcement of the merger to the public. We provide several hypotheses that link these two return variables, and discuss their relevance in our context.

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Three Essays In Cross-Border Finance

Choi, Moon. 2010. Three Essays In Cross-Border Finance. Doctoral Dissertation, Cornell University.

This Ph.D. dissertation investigates various areas in financial economics: market microstructure, corporate finance, asset pricing, and financial econometrics. The three comprising essays have a common ground: cross-border finance. Chapter One documents the impact of differential private information on relative asset pricing across borders by studying the probability of informed trading (PIN) for Canadian shares traded on exchanges separated by Niagara Falls. Relative to the New York Stock Exchange (NYSE), the Toronto Stock Exchange (TSX) has more informed trades and accounts for a larger information share, indicating that informed traders contribute to cross-border price discovery. The information imbalance across the two markets is associated with small but positive price premiums for New York trades. The dynamics of these premiums depends on trade informedness. Lastly, the PIN of a TSX -listed share typically rises upon cross-listing on the NYSE, which is consistent with negative abnormal returns of the original listing. The theory of corporate governance suggests that managers of poorly governed firms are more likely to make poor investment decisions, and the evidence on high antitakeover provision (ATP) firms is consistent. In Chapter Two, I study the effect of domestic and foreign takeovers by U.S. firms and find that high-ATP bidders tend to pay relatively high premiums for either targets. While this suggests that these firms make poor decisions, high-ATP bidders also experience relatively high event study returns at times of foreign takeover news. This contradicts the findings of Masulis et al. (2007) for domestic takeovers. Finally, Chapter Three explores the convergence between the prices of American Depositary Receipts (ADRs) listed by Asia-Pacific firms and their original shares listed on home exchanges. Instead of relying on conventional parametric approaches that carry embedded model-specification errors, I contribute to the literature by introducing a nonparametric technique to estimate the convergence speed parameter. I present the time-varying characteristics of both firm and country-level convergence speed parameters. Furthermore, I empirically verify and visually corroborate the comparative dynamics of convergence with respect to short sales restrictions, trading time differences, and market-tier measures proxied by the Morgan Stanley Capital International indices. I conclude that enhancement in market efficiency accelerates the reversion to the parity of ADR -pairs.

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Market Efficiency, Short Sales And Announcement Effects

Zheng, Lin. 2009. Market Efficiency, Short Sales And Announcement Effects. Doctoral Dissertation, Cornell University.

In this dissertation I aim at improving the understanding of the informativeness of short-selling in the context of the motivation, the impact on future stock returns, and the relation with market efficiencies. In Chapter 1, I study short sellers? reactions after quarterly earnings announcements as well as the associations between short sales and post announcement stock returns. Short sales increase immediately after both negative and positive earnings surprises. After positive earnings surprises, short sellers appear to act as contrarians, and trade against stock price overreaction, thereby inducing price reversal in the long run. After negative earnings surprises, short sellers act as momentum traders, and trade with post earnings announcement drift. However, they are not able to fully arbitrage away the downside post earnings announcement drift. The short sellers? different reactions at subsequent surprises in a series of same-sign earnings surprises implies that short sellers exploit the consequences of other investors? behavioral biases. The results highlight the motivations and impacts for short sales after earnings announcements. In Chapter 2, I investigate the informativeness of short-selling by combining Probability of Information-based Trading measure and short sales transaction data. Short sales depress stock returns in the short run, regardless of the information asymmetry level. However, short sales can not predict future stock return in the long run if information asymmetry levels are low. Large size short sales are the most informed. When short sales constraints are more binding, short-selling is more informed, especially for the stocks with high information asymmetry levels. In Chapter 3, I examine short sales prior to merger and acquisition announcements for acquiring firms. Short-selling increases prior to stock-financed not cash-financed mergers and acquisitions. Pre-announcement abnormal short-selling is negatively related to post-announcement stock returns. Short sellers are informed of the method of payment, but not the outcome. The results also indicate that short-sellers are more active in stocks with larger firm size, lower book-to-market ratio, and higher liquidity.

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Three Essays On Financial Policy Of A Firm

Larkin, Yelena. 2012. Three Essays On Financial Policy Of A Firm. Doctoral Dissertation, Cornell University.

The first chapter of the dissertation analyzes how characteristics of a firm's brand affect financial decisions by using a proprietary database of consumer brand evaluation. It demonstrates that positive consumer attitude alleviates financial frictions by providing more net debt capacity, as measured by higher leverage and lower cash holdings. Brand perception reduces the overall riskiness of a firm, as strong consumer evaluations translate into lower future cash flow volatility, higher Z-scores, and better performance during recession. Creditors favor strong brands by demanding lower yields on corporate public bonds. The results are more pronounced among small firms and non-investment grade bonds, contradicting a number of reverse causality and omitted variables explanations. The second chapter develops a framework that shows how exactly market timing and trade-off forces coexist. The idea is that market timing benefits dominate trade-off costs when firms are close to their target leverage, but become offset by the rebalancing considerations when firms are farther away. Two sets of empirical results support the validity of the framework. First, the sensitivity of equity issuances to past stock performance is the highest among firms close to the target leverage. Second, the long-run performance of equity issuers is also a function of their deviation from target leverage. The lower the leverage of issuing firms is relative to the target, the worse their after-issuance returns are, consistent with higher market timing incentives compared to other issuers. The third chapter studies whether investors value dividend smoothing stocks differently by exploring the implications of dividend smoothing for firms' expected returns and their investor clientele. First, it demonstrates that dividend smoothing is associated with lower average stock returns in both univariate and multivariate settings. Some of this return differential can be attributed to lower risk, captured by return comovement among high (low) smoothing firms. Second, the chapter shows that institutional investors, and specifically, mutual funds, are more likely to hold dividend smoothing stocks. Last, firms that smooth their dividends issue equity more frequently. Together, these results are consistent with the role of dividend smoothing in mitigating the impact of agency conflicts on the cost of capital.

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Reaction of Stock Market to Monetary Policy Surprises

Wiranto, Wellian. 2008. Reaction of Stock Market to Monetary Policy Surprises. Doctoral Dissertation, Cornell University.

This paper provides an empirical analysis of stock market reactions to monetary policy surprises. Its principal objective is to understand the heterogeneous nature of this type of response by examining a set of possible explanatory factors. I find that a hypothetical unanticipated increase of 25 bps in the target Federal Reserve funds rate would result in a one-day decline of 1.3 percent in the prices of S&P 500 stocks. There is some evidence that factors such as sector and industry groups, firm size, and the foreign earnings exposure of a firm could affect the reaction reflected in its stock price. The severity of the equity market’s response also appears to be associated with elements of the macroeconomic environment such as the level of prevailing interest rates and inflation expectations. Moreover, my results suggest that a lack of unanimity in the FOMC votes could curb the reaction of the stock market.

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A Cross-Time Study Of U.S. Earnings, Splits, And Dividends Data

Motelson, Kerry. 2009. A Cross-Time Study Of U.S. Earnings, Splits, And Dividends Data. Doctoral Dissertation, Cornell University.

This paper details the share price reaction to dividend, earnings, and stock split announcements over a 37-year period. It first considers whether there is differential information content in similar corporate news announcements for different types of firms. Second, it investigates whether the value of news information about these firms has declined over time (addressing the question of whether news has become "less newsworthy").

We go on to study the relationship between stock price reactions to corporate news announcements and characteristics of the firms. Operating under the assumption that news announcements have an asymmetrical impact on stock price according to factors like firm size, years of being publicly traded, or industry classification, we categorize firms by whether their corporate news announcements will be more or less valuable to the public. For example, since the public may know more about larger firms, we expect the market to react less strongly (in absolute value) to new information from large firms. We find strong support for this hypothesis. We find little evidence that is consistent with the idea that "news has become less newsworthy" over the past four decades. However, although we do find that the share price reaction to "good" dividend news has become less positive and to "bad" dividend news has become less negative over time, no such related evidence exists for stock splits and earnings announcements.

We also find an increase in standard deviation of three day returns around earnings and splits announcements over time, with noteworthy convergence amongst positive, negative and neutral earnings announcements. Additional investigation of entire distributions of returns using kernel density estimators also rejects the "news is no longer newsworthy" idea.

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Price Discovery And Liquidity In A Fragmented Stock Market

Ye, Mao. 2011. Price Discovery And Liquidity In A Fragmented Stock Market. Doctoral Dissertation, Cornell University.

One of the most striking changes in U.S. equity markets has been the proliferation of trading venues. My dissertation studies the impact of market fragmentation on liquidity and price discovery from three different perspectives. The first section, coauthored with Maureen O'Hara, examines how fragmentation of trading is affecting the quality of trading. We use newly-available trade reporting facilities volumes to measure fragmentation levels in individual stocks, and we use a matched sample to compare execution quality and efficiency of stocks with more and less fragmented trading. We find market fragmentation generally reduces transaction costs, as measured by effective spread and realized spread, and increases execution speeds. Fragmentation does increase short-term volatility, but prices are more efficient in that they are closer to being a random walk. The second section focuses on a particular type of new trading mechanism, crossing network, in which buy and sell orders are passively matched using the price set by the stock exchange. The results show that the crossing network harms price discovery and the relative lack of revealed information most strongly affects stocks with high uncertainty in their fundamental values. I find that an increase in the uncertainty of the fundamental value of the asset increases the transaction costs in both markets, but stocks with higher fundamental value uncertainty are more likely to have higher market shares in the crossing network. The impact of different allocation rules in the crossing network on market outcomes is also examined. The third section tests the theoretical prediction of the second essay. I find that crossing networks have lower effective spread and price impact of trade, but they also have lower execution probability and speed of trade. Non-execution is positive correlated with price impact, decreases in trading volume and increases in volatility. Crossing networks have higher market share for stocks with lower volatility and higher volume. We also find that the underlying assumption in previous literature, that stocks with higher effective spreads have higher reductions in effective spread by trading in crossing networks, is not supported by data.

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Three Essays On Market Efficiency: Global Price Leadership, Informal Parallel Markets, And Market Microstructure

Tanompongphandh, Thanasin. 2011. Three Essays On Market Efficiency: Global Price Leadership, Informal Parallel Markets, And Market Microstructure. Doctoral Dissertation, Cornell University.

This dissertation tackles the concept of market efficiency from three distinct topics in applied economics, from microfinance, to agriculture commodity market, and further to market microstructure of the most advanced economy. The first essay, entitled "Market Efficiency and Price Discovery Among Leading Rice Exporting Countries", focuses on the issue of rice market efficiency. The study establishes, under Johansen's procedure, that there are long-run price co-movements existing among the three major rice-exporting countries, and within the United States domestic markets, the long-run efficient linkage between spot and future prices of rough rice, as Chicago Board of Trade rough rice futures converge to United States Department of Agriculture rough rice prices in a cash market. Regarding the efficiency among the export market prices, results show that the hypothesis of market efficiency are rejected in two of the three pairs, namely Thai-Vietnam and ThaiUS (Arkansas). The Gonzalo Granger (1995) decomposition method finds that the Thai and United States rice are dominant in the price discovery process. Within the United States domestic markets, the dominant is the futures market followed by the cash market of the rough rice and then the milled rice export price. The second essay, entitled "Determinants for Formal Credit and Informal Credit Access: The Case of Thai Farm Households", examines determinants for Thai agricultural households' participation in formal and its informal parallel credit markets. The study follows Heckman's two-stage selection model (1979) approach to determine the informal loan participation of Thai agricultural households. Results reveal that households tend to 'stick' to the credit market in which they were previously engaged. This finding reinforces the vicious cycle which makes it more difficult for farmers to get out of debt. Secondly, the study finds that wealthier households are less likely to access credit, and are more likely to participate in formal credits than their less wealthy peers. Results also show less probability of credit access between May and December coinciding with the planting and harvesting season accentuating the nature of loans as working-capital rather than consumption loans. Finally, the study discovers that households with owned farmland are more likely to participate in the formal credit market, while households with rented farmland are more likely to participate in the informal credit market stressing the use of owned land as collateral to participate in the former. The final essay, entitled "On the Challenge of Testing Weak-Form Market Efficiency using High Frequency Data", explores the issue of efficiency in microstructure of the Exchange-Traded-Fund (ETF). This essay shows that the profitability of a simple technical trading strategy hinges heavily on the way the Trades And Quotes (TAQ) dataset is filtered for mistakes and outliers. This paper uses ultra-high-frequency TAQ data that cover the time-span since the inception of the S& P 500 ETF from January 1993 to December 2006. First, a widely used filtering methodology proposed by Hasbrouck (2003) is adopted. Under this methodology, the technical trading strategy clearly outperforms the buy-and-hold benchmark. However, when a more appropriate (stringent) filtering methodology is used, the technical trading strategy clearly underperforms the buy-and-hold benchmark. This evidence suggests that studies that based their methodology on Hasbrouck's (2003) less stringent filtering criterion could produce misleading results.

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The Effects Of Government Sponsored Enterprise Status On The Pricing Of Bonds Issued By The Federal Farm Credit Banks Funding Corporation

Wang, Yiwo. 2011. The Effects Of Government Sponsored Enterprise (Gse) Status On The Pricing Of Bonds Issued By The Federal Farm Credit Banks Funding Corporation (Ffcb). Doctoral Dissertation, Cornell University.

This thesis develops a framework to price the implicit government guarantee embedded in the bonds issued by the Farm Credit System. It shows that the value of the implicit government guarantee for a specific bond is dependent on the yield spread, the risk-free interest rate, the maturity and the future value of the bond price. It also reconfirms Merton's theory (1974) that yield spreads are influenced by variances of the firm (volatility square), maturity and quasi debt to collateral value ratio (d-ratio). Furthermore, the hypothetical bond yields for the Farm Credit System bonds without GSE status are calculated based on the Black-Scholes Model.

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Mathematical Models For Swing Options And Subprime Mortgage Derivatives

Diener, Nicolas. 2009. Mathematical Models For Swing Options And Subprime Mortgage Derivatives. Doctoral Dissertation, Cornell University.

The deregulation of the energy market and the recent soaring (and possible bubble) of commodity prices motivates the first part of the thesis. We analyze a certain kind of contract in the commodity market known as swing or take-or-pay options. These contracts are American type options where the holder has multiple exercise rights. The goal is to find the optimal consumption process for the underlying commodity. We present a pricing methodology using the theory of reflected backward stochastic differential equations and the theory of Snell envelopes. Once the model is constructed, one can use numerical techniques to solve the pricing problem and compute a replicating strategy using forward contracts. The recent burst of the real estate bubble has drawn a lot of attention to the subprime derivatives market. Existing models have proven inadequate due to their inability to account for the complexity of mortgage derivatives. Chapter 3 provides an analytical framework for understanding the mortgage market. In Chapter 4, we give a condition on the underlying securities that allows us to directly compute the loss distribution term structure of the portfolio. Then, we build a tractable model for pricing options on large credit portfolios such as Collateralized Debt Obligations of subprime Asset Backed Securities / Home Equity Loans.

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Essays On The Specification Testing For Dynamic Asset Pricing Models

Yun, Jaeho. 2009. Essays On The Specification Testing For Dynamic Asset Pricing Models. Doctoral Dissertation, Cornell University.

This dissertation consists of three essays on the subjects of specification testing on dynamic asset pricing models. In the first essay (with Yongmiao Hong), "A Simulation Test for ContinuousTime Models", we propose a simulation method to implement Hong and Li's (2005) s transition density-based test for continuous-time models. The idea is to simulate a sequence of dynamic probability integral transforms, which is the key ingredient of Hong and Li's (2005) test. The proposed procedure is generally applicable s whether or not the transition density of a continuous-time model has a closed form and is simple and computationally inexpensive. A Monte Carlo study shows that the proposed simulation test has very similar sizes and powers to the original Hong and Li's (2005) test. Furthermore, the performance of the simulation test s is robust to the choice of the number of simulation iterations and the number of discretization steps between adjacent observations. In the second essay (with Yongmiao Hong), "A Specification Test for Stock Return Models", we propose a simulation-based specification testing method applicable to stochastic volatility models, based on Hong and Li (2005) and Johannes et al. (2008). We approximate a dynamic probability integral transform in Hong and Li's s (2005) density forecasting test, via the particle filters proposed by Johannes et al. (2008). With the proposed testing method, we conduct a comprehensive empirical study on some popular stock return models, such as the GARCH and stochastic volatility models, using the S&P 500 index returns. Our empirical analysis shows that all models are misspecified in terms of density forecast. Among models considered, however, the stochastic volatility models perform relatively well in both in- and out-of-sample. We also find that modeling the leverage effect provides a substantial improvement in the log stochastic volatility models. Our value-at-risk performance analysis results also support stochastic volatility models rather than GARCH models. In the third essay (with Yongmiao Hong), "Option Pricing and Density Forecast Performances of the Affine Jump Diffusion Models: the Role of Time-Varying Jump Risk Premia", we investigate out-of-sample option pricing and density forecast performances for the a¢ ne jump diffusion (AJD) models, using the S&P 500 stock index and the associated option contracts. In particular, we examine the role of time-varying jump risk premia in the AJD specifications. For comparison purposes, nonlinear asymmetric GARCH models are also considered. To evaluate density forecasting performances, we extend Hong and Li's (2005) specification s testing method to be applicable to the famous AJD class of models, whether or not model-implied spot volatilities are available. For either case, we develop (i) the Fourier inversion of the closed-form conditional characteristic function and (ii) the Monte Carlo integration based on the particle filters proposed by Johannes et al. (2008). Our empirical analysis shows strong evidence in favor of time-varying jump risk premia in pricing cross-sectional options over time. However, for density forecasting performances, we could not find an AJD specification that successfully reconcile the dynamics implied by both time-series and options data.

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Institutional Ownership, Liquidity and Liquidity Risk

Agarwal, Prasun. 2009. Institutional Ownership, Liquidity and Liquidity Risk. Doctoral Dissertation, Cornell University.

In this dissertation, I focus on examining the effects of institutional ownership on stocks' liquidity and liquidity risk using a sample of firms listed on the NYSE and the AMEX over the period 1980-2005. The first chapter provides a brief introduction to liquidity and emphasizes the role of institutional ownership in financial markets. In the second chapter, I examine the relationship between institutional ownership and liquidity of stocks, focusing on the effect of institutions' relative information advantage. The information advantage of institutions can affect liquidity through two channels: decreasing liquidity resulting from increasing information asymmetry (adverse selection effect) and increasing liquidity resulting from increasing price discovery due to competition among institutions' information efficiency effect.

My evidence indicates a non-monotonic (U-shaped) relationship between the level of institutional ownership and stock liquidity. The two effects vary with the amount of publicly available information and asset risk. I also find that institutional ownership (Granger) causes liquidity, allaying concerns that the findings result from institutions' preference for liquid stocks. Lastly, I document that liquidity decreases with increasing diversification of the portfolio of institutional investors and the fraction of equity held by long-term investors.

In the third chapter, I examine the effects of institutional ownership on stocks' time variation in liquidity. It helps advance an understanding of the sources of commonality in liquidity and the determinants of the sensitivity of an asset's liquidity to changes in market-wide liquidity (systematic liquidity risk) and the total variance of liquidity of a firm over time. I interpret my findings in the context of correlated trading by institutions resulting either from their tendency to herd or to trade on common information and signals. I find that systematic liquidity risk increases with the level of institutional ownership, homogeneity and investment-horizon of the institutional investor base, while it decreases with ownership concentration and increase in blockholdings. However, the variance of liquidity decreases with the level of institutional ownership, homogeneity of the investor base and ownership concentration. Overall, the findings indicate that the ownership structure of stocks affects both the systematic liquidity risk and the variation in their liquidity over time.

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Essays On Asset Pricing: Predictability, Information, And Liquidity

Chen, Qingqing. 2009. Essays On Asset Pricing: Predictability, Information, And Liquidity. Doctoral Dissertation, Cornell University.

This dissertation is a collection of essays on Asset Pricing: Predictability, Information, and Liquidity. The first chapter, Predictability of Equity Returns over Different Time Horizons: A Non-parametric Approach? aims to test an important hypothesis in financial economics: whether equity returns are predictable over various horizons? We first propose a non-parametric test to examine the predictability of equity returns, which can be interpreted as a signal-to-noise ratio test. Our empirical results show that the short rate, dividend yields and earnings yields have good predictability power for both short and long horizons, which is different from both the conventional wisdom and Ang and Bekaert (2007). Also, using our non-parametric test, a comprehensive in-sample and out-of-sample analysis documents that the predictor variables (dividend yields, earnings yields, dividend payout ratio, short rate, inflation, book-to-market ratio, investment to capital ratio, corporate issuing activity, and consumption, wealth, and income ratio) have predictability power on equity returns but this cannot be well captured by linear prediction models. In addition, we use the nonparametric test to compare the conventional long-horizon prediction regression models on predictor variables with the historical mean model, where there has exists a debate about which model has better forecasting power for equity returns (Campbell and Thompson (2007) and Goyal and Welch (2007)). We find that the prevailing prediction model has a better forecasting power than the historical mean model because the former has a lower neglected signal-to-noise ratio. Finally, we find that our nonparametric predictive models have lower RMSE than the historical mean model at both short-horizon and long-horizon. Using our non-parametric methods, both combined and individual forecast outperform the historical average. The second chapter, An Intraday Analysis of Related Investment Vehicles Traded in the NYSE and AMEX? undertakes an intraday analysis of related, investment vehicles traded in the NYSE and AMEX. I investigate how the trading behaviors of three related investment vehicles (American Depository Receipt, Exchange-traded Fund, and Closed-end Fund) differ across countries using high-frequency intraday data. I ?nd that ADRs trade at transaction prices that are on average worse than ETFs and CEFs. The trading of ADRs, ETFs, and CEFs follows positive feedback strategies. The buy and sell trades of the three securities are driven by the net order imbalances and past returns of three securities themselves. The correlated trading behaviors of the three securities can be explained by momentum traders with a common information set. The third chapter, “Endogenous Information Acquisition, Cost of Capital, and Comovement of Equity Returns” investigates endogenous information acquisition, , cost of capital, and comovement of equity returns. The traditional asset pricing model cannot provide a good explanation for the comovement of asset returns. This chapter introduces endogenous costly information acquisition that generates comovement of asset returns in a rational expectations framework. The private information signals observed by many investors contain information not only about the value of the asset itself, but also the value of many other assets. This common source of information causes excessive covariance in their returns. If informed investors acquire more private information, or more investors are informed, the comovement of asset returns will increase. On the other hand, if informed investors aggressively obtain abundant private information, the comovement will decrease. We also find that both greater precision in private information and higher cost of information will increase a company cost of capital’s.

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Factor Models For Call Price Surface Without Static Arbitrage

Zhu, Fan. 2012. Factor Models For Call Price Surface Without Static Arbitrage. Doctoral Dissertation, Cornell University.

Although stochastic volatility models and local volatility model are very popular among the market practitioner for exotic option pricing and hedging, they have several critical defects both in theory and practice. We develop a new methodology for equity exotic option pricing and hedging within the market based approach framework. We build stochastic factor models for the whole surface of European call option prices directly from the market data, and then use this model to price exotic options, which is not liquidly traded. The factor models are built based on Karhunen-Loeve decomposition, which can be viewed as an infinite dimensional PCA. We develop the mathematical framework of centered and uncentered versions of the Karhunen-Loeve decomposition and study how to incorporate critical shape constraints. The shape constraints are important because no static arbitrage conditions should be satisfied by our factor models. We discuss this methodology theoretically and investigate it by applying to the simulated data.

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Essays On Risk Biased Exports And Liquidity-Based Determinants Of International Equity Flows

Serechetapongse, Anuk. 2013. Essays On Risk Biased Exports And Liquidity-Based Determinants Of International Equity Flows. Doctoral Dissertation, Cornell University.

This dissertation is comprised of three essays. Chapter One develops a general equilibrium framework to address risk-shifting factors in a country allocation of resources between the domestic and export sector. The analytical framework introduces credit frictions as in Allen and Gale (2000) to the general equilibrium model of Helpman and Razin (1978), which features the allocation of factors of production across two sectors of an open economy under uncertainty. The risk bias hinges on the imperfect ability of lenders to monitor the usage of the borrowed funds. Borrowers would invest more on the equities of the risky production sector. This is because if the returns of those equities are high, they would repay the promised return and keep the remaining profits from their investment. However, if the returns are low, they can just default and avoid further losses. Such risk-shifting behavior, which tends to make the risky (export) sector equities overpriced, will lead to also to overinvestment in this sector, and excessive allocation of labor to it. As a result, the production and export pattern to be geared towards the risky sector, which may expose a country to increased macroeconomic volatility. Chapter Two provides an empirical test to key predictions of the theory, which is developed in Chapter One. Specifically, it uses cross-country panel data to test whether low degree of monitoring borrowers by financial intermediaries would contribute to a shift in a country's exports towards risky production sectors. It analyzed the data measuring the riskiness across sectors, developed by Koren and Tenreyro (2007) and Di Giovanni and Levchenko (2011), from developed and developing economies over the period of 1978-2004. The explanatory variable of interest is the creditor rights index (CRI) because it captures the degree of enforcing debt repayment and thus reflects the lenders' ability to observe the borrowers' actions. The dependent variable is the risk content of exports index, which is constructed by multiplying the square of each sector's share of exports to the variance of the sectoral value added growth. The higher value of the index indicates that a country has higher shares of exports in the sectors whose productions are more volatile. Using fixed effects regressions, the results revealed that countries where lenders have lower ability to monitor borrowers are the ones with higher risk content of exports. This finding remained robust even after excluding the most volatile production sectors from the analysis. And when separately examining the effects of the four different components of creditor rights index, it is shown that the effects of creditor rights arises from the restrictions on the borrowers' filing for reorganization. Chapter Three, addressing international equity flows, provides empirical tests to three theory-based hypotheses concerning foreign equity investment in the presence of liquidity risk. First, the FDI-to-FPI price differential is negatively related to liquidity risk (the "Price Discount Hypothesis"). The idea is that direct investments would incur a price discount because market participants do not know whether the FDI investor liquidates a firm because of an idiosyncratic liquidity shock, or because, as an informed investor, the firm is hit by a productivity shock. Second, the FDI-to-FPI composition would skew towards FPI if investors expect to experience liquidity shortage in the future (the ""Equity-Composition Hypothesis"). Since direct investments are more costly to liquidate, due to the price discount, investors would be inclined to hold less FDI if they expect more severe liquidity shock. The third hypothesis, on the other hand, states that the FDI-to-FPI composition would skew towards FDI if the past FDI-to-FPI stocks were larger (the "Strategic Complementarity Hypothesis"). If the initial proportion of direct investments is higher, it is more likely that a direct investment is sold due to liquidity needs. This improves the price of the prematurely sold direct investment, creating an incentive for more investors to choose FDI rather than FPI. These hypotheses are examined using the country level data consisting of a large set of developed and developing countries over the period 1970 to 2004. The nationwide sales of external assets are used as a proxy for liquidity problems, and the effect of expected liquidity problems on stock prices, the ratio of FPI to FDI and gross flows of FDI and FPI are tested. The empirical results support the three hypotheses.

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