Here’s MoreLiver’s Thursday Back to School research recap. Some of the summaries are truncated. Most of this is lifted from @quantivity twitterfeed, NBER and the blogs I follow. Topics this week: Quant Stuff, Economics, Anomalies / Predicting, and Portfolio Management.
QUANT STUFF
Dimension Reduction: A Guided Tour – Microsoft (pdf)
by Christopher J.C. Burges: We give a tutorial overview of several foundational methods for dimension reduction. We divide the methods into projective methods and methods that model the manifold on which the data lies.
Power laws in finance – The Physics of Finance
These are only a few of the power law type regularities now known to hold for most markets, with only very minor differences between markets. An important effort is to find ways to explain these regularities in simple and plausible market models. None of these patterns can be explained by anything in the standard economic theories of markets (the EMH etc).
ECONOMICS
Macroeconomic effects of unconventional monetary policy in the euro area – ECB
Eurosystem central banks can stimulate the economy beyond the policy rate by increasing the size of its balance sheet, however the effects are short-lived
Credit Growth and Bank Soundness: Fast and Furious? – IMF (pdf)
The authors examine the risks posed to bank soundness by booms in a variety of countries. Using bank-level data in 90 countries between 1995 and 2005, they analyse the relationship between credit growth and bank soundness, taking into account the potential two-way causality. The paper finds that, while sounder banks tend to grow faster in moderate growth periods, credit growth becomes less dependent on soundness during booms, going some way to explaining why credit booms are often associated with financial crises.
Asset Price Booms and Current Account Deficits – FRBSF
Before the global financial crisis of 2007–2009, the United States and several other countries posted large current account deficits. Many of these countries also experienced asset price booms. Evidence suggests the two developments were linked. Rising asset values in the United States permitted households to borrow more easily to boost consumption, while the net sale of debt securities abroad financed current account deficits. The fall in some asset prices since the crisis can make it easier to reduce current account imbalances.
How Costly Are Debt Crises? – IMF
The aim of this paper is to assess the short- and medium-term impact of debt crises on GDP. Using an unbalanced panel of 154 countries from 1970 to 2008, the paper shows that debt crises produce significant and long-lasting output losses, reducing output by about 10 percent after eight years. The results also suggest that debt crises tend to be more detrimental than banking and currency crises. The significance of the results is robust to different specifications, identification and endogeneity checks, and datasets.
House Prices and Current Account Deficits – The Street Light
So if we believe that there is indeed a causal relationship between house price appreciation and current account deficits, what's the explanation?
Globalization in an Age of Crisis: Multilateral Economic Cooperation in the Twenty-First Century - NBER
Forthcoming book, articles include: Coping with Shocks and Shifts: The Multilateral Trading System in Historical Perspective · International Policy Coordination: The Long View · Can the Doha Round be a Development Round? Setting a Place at the Table · Preferential Trade Agreements and the World Trade System: A Multilateralist View · Facing the Climate Change Challenge in a Global Economy · Trade and Industrialisation after Globalisation’s Second Unbundling: How Building and Joining a Supply Chain are Different and Why it Matters · Multilateral Economic Cooperation: The Role of Fiscal Policy · The International Monetary System: Living with Asymmetry · Global Macroeconomic and Financial Supervision: Where Next?
Are Recoveries from Banking and Financial Crises Really So Different? – FED
… we find little or no difference in the pace of output growth across types of recessions. In particular, banking and financial crisis do not affect the strength of the economic rebound, although these recessions are more severe, implying a sizable output loss. However, recovery does change with some characteristics of recession. Recoveries tend to be faster following deeper recessions, especially in emerging markets, and tend to be slower following long recessions. Most recessions are associated with a slowing, if not outright decline in house prices, but recessions with large declines in house prices also tend to have slower recoveries. Long recessions and those associated with poor housing-market outcomes can lead to sustained output losses relative to pre-crisis trends.
ANOMALIES / PREDICTING
The predictive power of approximately 2.5 million stock predictions submitted by individual users to the 'CAPS' website run by the Motley Fool company. The data used in this analysis spans the time period between November 2006 and December 2008, a period with significant swings in stock market performance…shorting stocks with a disproportionate number of negative picks ... and buying stocks with a disproportionate number of positive picks produces a return of over 9 percent per annum.
The 52-Week High Strategy and Information Uncertainty – SSRN
This paper examines the driver of the 52-week high strategy, which is long in stocks close to their 52-week high price and short in stocks with a price far below their one-year high, and tests the hypothesis that this strategy’s profitability can be explained by anchoring - a behavioral bias. To test the null, we examine whether the 52-week high criterion has more predictive power in cases of larger information uncertainty. This hypothesis is based on the psychological insight that behavioral biases increase in uncertainty. For six proxies of ambiguity, we document a positive relationship to returns of 52-week high winner stocks and a negative relationship to returns of 52-week high loser stocks. The opposite effect of information uncertainty on winner and loser stocks implies that the 52-week high profits are increasing in uncertainty measures. Moreover, the study documents that the six variables have a similar impact on momentum profits. Hence, we cannot reject the hypothesis that anchoring explains the profits of the 52-week high strategy and that it is the driver of the momentum anomaly.
This paper examines the driver of the 52-week high strategy, which is long in stocks close to their 52-week high price and short in stocks with a price far below their one-year high, and tests the hypothesis that this strategy’s profitability can be explained by anchoring - a behavioral bias. To test the null, we examine whether the 52-week high criterion has more predictive power in cases of larger information uncertainty. This hypothesis is based on the psychological insight that behavioral biases increase in uncertainty. For six proxies of ambiguity, we document a positive relationship to returns of 52-week high winner stocks and a negative relationship to returns of 52-week high loser stocks. The opposite effect of information uncertainty on winner and loser stocks implies that the 52-week high profits are increasing in uncertainty measures. Moreover, the study documents that the six variables have a similar impact on momentum profits. Hence, we cannot reject the hypothesis that anchoring explains the profits of the 52-week high strategy and that it is the driver of the momentum anomaly.
Memory effects in stock price dynamics: evidences of technical trading – arxiv
...we investigate if technical trading produces detectable signals in price time series and if some kind of memory effect is introduced in the price dynamics. In particular we focus on a specific figure called supports and resistances. We first develop a criterion to detect the potential values of supports and resistances. As a second step, we show that memory effects in the price dynamics are associated to these selected values. In fact we show that prices more likely re-bounce than cross these values.
Investing in the Turn-of-the-Year Effect – SSRN
The January effect is concerned with high stock returns in January, especially by small cap stocks. Transactions costs, especially price pressures, make it difficult to take advantage of this anomaly. However, these costs are minimal in the futures markets. This paper discusses the results of small minus large capitalized US stocks since futures trading began in 1982. There is some anticipation of the effect and in the futures markets; the anomaly still exists but is now totally in December.
Equity Real Estate Investment Trust (REIT) Anomalies to Market Efficiency: Momentum and Drift – SSRN
…the continuation of past price movements (momentum) and the incomplete reaction to earnings news (post-earnings-announcement drift). With the former having long been established in REIT returns, and the latter having only recently been documented, we show that the two returns phenomena are highly related in the cross-section of industry-level returns, with drift being of greater magnitude and significance. Additionally, in time-series tests we demonstrate that the payoff to a REIT momentum strategy is subsumed by REIT drift.
Money Velocity and the Stock Market – CXO Advisory
Evidence from several simple tests provides perhaps slight support for a belief that quarterly change in money velocity is a useful predictor of stock market behavior
Learning from experience in the stock market – ECB (pdf)
We study the dynamics of a Lucas-tree model with finitely lived agents who learn from experience. Individuals update expectations by Bayesian learning based on observations from their own lifetimes. In this model, the stock price exhibits stochastic boom-and-bust fluctuations around the rational expectations equilibrium. This heterogeneous-agents economy can be approximated by a representative-agent model with constant-gain learning, where the gain parameter is related to the survival rate.
High Frequency Lead/lag Relationships - Empirical facts – arxiv
We confirm the intuition that the most liquid assets (short intertrade duration, narrow bid/ask spread, small volatility, high turnover) tend to lead smaller stocks. However, the most correlated stocks are those with similar levels of liquidity. This lead/lag phenomenon is not constant throughout the day, it shows an intraday seasonality with changes of behaviour at very specific times such as the announcement of macroeconomic figures and the US market opening.
PORTFOLIO MANAGEMENT
Research Review: Market Timing & Risk Management – The Capital Spectator
A Risk Based Approach to Tactical Asset Allocation · How Expected Shortfall Can Simplify the Equally-Weighted Risk Contribution · PortfolioTime-Varying Fund Manager Skill · Managing Sovereign Credit Risk in Bond Portfolios · Time-Varying Sharpe Ratios and Market Timing · The Joint Dynamics of Equity Market Factors.
The Nature of Alpha – arxiv
We suggest an empirical model of investment strategy returns which elucidates the importance of non-Gaussian features, such as time-varying volatility, asymmetry and fat tails, in explaining the level of expected returns. Estimating the model on the (former) Lehman Brothers Hedge Fund Index data, we demonstrate that the volatility compensation is a significant component of the expected returns for most strategy styles, suggesting that many of these strategies should be thought of as being `short vol'. We present some fundamental and technical reasons why this should indeed be the case, and suggest explanation for exception cases exhibiting `long vol' characteristics. We conclude by drawing some lessons for hedge fund portfolio construction.
The Variance Risk Premium Around the World – FED (pdf)
I provide new evidence on the basic stylized facts traditionally documented for the US. I show that while the variance premiums in several other countries are, on average, positive and display significant time variation, they do not predict local equity returns. Then, I extend the domestic model in Bollerslev, Tauchen and Zhou (2009) to an international setting. In light of the qualitative implications of my model, I provide empirical evidence that the US variance premium outperforms that of all other countries in predicting local and foreign equity returns.
Déjà Vu All Over Again – Morningstar (pdf)
When risk models fall short, advisors need to look no further than the historical record to plan for the next 100-year flood.
The Real World is Not Normal – Morningstar (pdf)
Introducing the new frontier: an alternative to the mean-variance optimizer