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21. On Returns Differentials

Author:
Stephanie E. Curcuru, Charles Thomas, and Francis E. Warnock
Publication Date:
04-2013
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Estimates of U.S. returns differentials have ranged from exorbitant to quite small, in part because of their volatility coupled with the relatively short time series available. We shed light on underlying drivers of returns differentials by presenting a number of decompositions: a by-asset-class decomposition into yields and capital gains, the Gourinchas and Rey (2007a) composition and return effects, and further decompositions of capital gains that focus on exchange rate effects. While each decomposition informs thinking about returns differentials, one constant is evident throughout: to date the existing differential favoring the U.S. has owed primarily to one factor, a differential in direct investment yields. We discuss how our analysis informs the income puzzle (of positive net income flows to the U.S. even as its net international investment position is negative and substantial) and the position puzzle (of a sizeable gap between the reported U.S. net international position and cumulated current account deficits), provide an initial assessment of the literature on the dynamics of returns differentials, and present a framework to guide a forward-looking view of how returns differentials might evolve in the future.
Topic:
Foreign Direct Investment, Financial Markets, Investment, and Stock Markets
Political Geography:
North America and United States of America

22. A Robust Neighborhood Truncation Approach to Estimation of Integrated Quarticity

Author:
Torben G. Andersen, Dobrislav Dobrev, and Ernst Schaumburg
Publication Date:
04-2013
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We provide a first in-depth look at robust estimation of integrated quarticity (IQ) based on high frequency data. IQ is the key ingredient enabling inference about volatility and the presence of jumps in financial time series and is thus of considerable interest in applications. We document the significant empirical challenges for IQ estimation posed by commonly encountered data imperfections and set forth three complementary approaches for improving IQ based inference. First, we show that many common deviations from the jump diffusive null can be dealt with by a novel filtering scheme that generalizes truncation of individual returns to truncation of arbitrary functionals on return blocks. Second, we propose a new family of efficient robust neighborhood truncation (RNT) estimators for integrated power variation based on order statistics of a set of unbiased local power variation estimators on a block of returns. Third, we find that ratio-based inference, originally proposed in this context by Barndorff-Nielsen and Shephard (2002), has desirable robustness properties in the face of regularly occurring data imperfections and thus is well suited for empirical applications. We confirm that the proposed filtering scheme and the RNT estimators perform well in our extensive simulation designs and in an application to the individual Dow Jones 30 stocks.
Topic:
Economics, Markets, Models, and Stock Markets
Political Geography:
Global Focus

23. "Fool Me Once . . . " Did U.S. Investors Play it Safer in the European Debt Crisis?

Author:
Carol C. Bertaut, Fang Cai, and Nyssa Kim
Publication Date:
08-2013
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper examines U.S. investors' portfolio investment patterns since the global financial crisis, particularly since the European debt crisis that began in late 2009. The global financial crisis during 2007-2009 was accompanied by an increase in U.S. investors' home bias. U.S. investors experienced significant valuation losses and pulled back notably from their foreign investment, especially from foreign debt. In contrast, while they have also incurred sizable losses on cross-border investment during the European debt crisis, U.S. investors so far have not shown any increase in home bias, and they have not even pulled back from their long-term investments in Europe. Holdings data show that U.S. investors have continued to invest in European securities, particularly in government debt, but have made little new investment in the financial sector. This continued interest in European securities could owe to the fact that most of U.S. holdings of European debt have been concentrated in dollar-denominated debt issued by core euro area countries and the United Kingdom, which are deemed relatively safe. Changes in the composition of holdings over the past couple years suggest that U.S. investors have behaved in a way that reflects their diversity and differing objectives: while investors reached for higher yields in government debt, there also appears to be some shift toward safer investment in the financial sector.
Topic:
Debt, Financial Crisis, Investment, Securities, and Stock Markets
Political Geography:
Europe, North America, and United States of America

24. Portfolio Diversification and the Cross-Sectional Distribution of Foreign Investment

Author:
Alexandra Tabova
Publication Date:
11-2013
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
In this paper I explore the role of portfolio diversification in explaining the distribution of foreign investment across countries. I capture the portfolio diversification motive by a measure of country-specific riskiness, "covariance risk", which I construct as how countries' growth rates covary with the stochastic discount factor of a representative international investor. My key new empirical finding is a strong and significant correlation between this new measure of country riskiness and foreign investment allocations. Less risky countries, i.e. countries whose growth rates are more highly correlated with the investor's stochastic discount factor, receive larger investment shares than more risky countries. I interpret this result as evidence that investors do take into account diversification opportunities, not only for portfolio investment decisions, but also for foreign direct investment decisions. My empirical results confirm the theoretical predictions of standard portfolio allocation models.
Topic:
Foreign Direct Investment, Investment, Risk, Fiscal Policy, Securities, and Stock Markets
Political Geography:
Global Focus

25. Variance Risk Premiums and the Forward Premium Puzzle

Author:
Juan M. Londono and Hao Zhou
Publication Date:
12-2012
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper presents evidence that the foreign exchange appreciation is predictable by the currency variance risk premium at a medium 6-month horizon and by the stock variance risk premium at a short 1-month horizon. Although currency variance risk premiums are highly correlated with each other over longer horizons, their correlations with stock variance risk premiums are quite low. Interestingly the currency variance risk premium has no predictive power for stock returns. We rationalize these findings in a consumption-based asset pricing model with orthogonal local and global economic uncertainties. In our model the market is incomplete in the sense that the global uncertainty is not priced by local stock markets and is therefore a forex-specific phenomenon—the currency uncertainty’s effects on the expected stock return are off-setting between the cash flow channel and the volatility channel.
Topic:
Economics, Risk, Currency, and Stock Markets
Political Geography:
Global Focus

26. Sovereign Credit Risk, Banks' Government Support, and Bank Stock Returns Around the World

Author:
Ricardo Correa, Kuan-Hui Lee, Horacio Sapriza, and Gustavo Suarez
Publication Date:
12-2012
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We explore the joint effect of expected government support to banks and changes in sovereign credit ratings on bank stock returns using data for banks in 37 countries between 1995 and 2011. We find that sovereign credit rating downgrades have a large negative effect on bank stock returns for those banks that are expected to receive stronger support from their governments. This result is stronger for banks in advanced economies where governments are better-positioned to provide that support. Our results suggest that stock market investors perceive sovereigns and domestic banks as markedly interconnected, partly through government guarantees.
Topic:
Sovereignty, Governance, Risk, Credit, Bonds, and Stock Markets
Political Geography:
Global Focus

27. U.S. International Equity Investment and Past Prospective Returns

Author:
Stephanie E. Curcuru, Charles Thomas, Francis E. Warnock, and Jon Wongswan
Publication Date:
02-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Counter to extant stylized facts, using newly available data on country allocations in U.S. investors' foreign equity portfolios we find that (i) U.S. investors do not exhibit returns-chasing behavior, but, consistent with partial portfolio rebalancing, tend to sell past winners; and (ii) U.S. investors increase portfolio weights on a country's equity market just prior to its strong performance, behavior inconsistent with an informational disadvantage. Over the past two decades, U.S. investors' foreign equity portfolios outperformed a value-weighted foreign benchmark by 160 basis points per year.
Topic:
Economics, Finance, Investment, Stock Markets, and Equity
Political Geography:
North America and United States of America

28. Limited Market Participation and Asset Prices in the Presence of Earnings Management

Author:
Bo Sun
Publication Date:
06-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We examine the role of earnings management in explaining the properties of asset prices and stock market participation. We demonstrate that investors' uncertainty about the extent of manipulation can cause excess movements in stock price relative to fluctuations in output. When faced with information asymmetry about fundamentals in the presence of earnings management, investors demand a higher equity premium for bearing the additional risk associated with their payoffs. In addition, when investors have heterogeneous beliefs about managerial manipulation, the dispersion in belief endogenously gives rise to limited stock market participation. Our model suggests that the increasing stringency of corporate governance and varying composition of investors may have played a role in the contemporaneous run-up of market participation rates in the recent years.
Topic:
Markets, Finance, Investment, and Stock Markets
Political Geography:
Global Focus

29. China’s Stock Market: A Marriage of Capitalism and Socialism

Author:
Sonia M. L. Wong
Publication Date:
10-2006
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
The rise of China’s stock market during the 1990s was nothing short of breathtaking. For more than 30 years after 1949, China was a centrally planned economy in which virtually all enterprises were state owned or collectively owned. Investments were centrally planned and funded by government fiscal grants as well as by loans from the state-owned monobank system as dictated by the government’s central credit plan. In the late 1980s, as part of enterprise reforms that took place during China’s gradual transition to a market economy, local governments in China started experimenting with selling shares of collectively owned enterprises directly to domestic individuals in order to raise equity capital. Curbed trading of enterprise shares soon began and was quickly followed by over-the-counter (OTC) trading in more organized but still informal exchanges. In 1991, two stock exchanges, one created by the Shanghai municipal government and the other by the Shenzhen municipal government, were launched, with the central government’s formal approval. Between 1992 and 2003, the market raised a total of 796.79 billion yuan of equity capital. At the end of 2003, China’s stock market had 1,287 listed enterprises and more than 70 million investor accounts (CSRC 2004).
Topic:
Economy, Investment, Socialism, State Capitalism, and Stock Markets
Political Geography:
China and Asia