An investigation of the equity premium using habit utility and equity returns: Australian evidence

The gap between the return on stocks and the return on the risk free assets represented by bonds is named the \u27Equity Premium\u27 or \u27Equity Risk Premium\u27. In the history of asset pricing models, one of the most serious problems for the equity premium is that the average equity premium is too large to be explained by standard general equilibrium asset pricing models. Researcher\u27s have tried to use variables such as dividend yield\u27s to explain the gap between stocks and bonds with mixed results. After retrieving around a one percent equity premium with the most standard consumption base asset pricing models or Lucas styled asset pricing model, Mehra and Prescott (1985) first recognised this problem and announced it as a \u27Puzzle\u27. In their analysis they used Lucas\u27s (1978) standard asset pricing model where a representative investor has additive and separable utility functions in the perfect market. Compared to other forms or utility functions, at a certain period, these conventional preferences derived from utility of consumption in previous periods. Also this utility maintains a constance risk aversion parameter, y, over the reasonable consumption boundaries. In this study two approaches are adopted. The first involves the commonly applied dividend yield approach to forecasting the equity premium. The results obtained from using the current and lagged divided yield to try to capture the size and movement in the market risk premium are shown in chapter three. The results are not particularly promising. The remainder of the dissertation is devoted to a more sophisticated model: the consumption capital asset pricing model with habit derived by Campbell and Cochrane (1995) is tested using Australian data. The utility specification separates the temporal choice from state contingent choice and in doing so resolves part of the equity premium puzzle. The model is able to generate an equity premium using consumption data that is collinear with the actual premium, but with a significantly different volatility. The conclusion is that the state and time separable model is only partly able to resolve Mehra and Prescott’s (1985) equity premium puzzle

Price dynamics of polypropylene and its feedstocks in Asia and North West Europe

Purpose: To investigate the spot price dynamics of the polypropylene (PP) value chain in the Far East and North West Europe and discusses some of the main drivers of PP prices. Originality: The paper is motivated by the recent and growing debate on whether PP prices are cost or demand driven and we test this by looking at the lead-lag relationship between the prices of PP and its feedstocks. This relationship has not been tested previously. Key literature / theoretical perspective: To date, no published study is available that investigates the price dynamics of upstream and downstream value chains in the olefins, aromatics and downstream plastic and polymer industries. The relation between upstream and downstream prices is evident in several studies that model the dynamics between crude oil prices and refined petroleum products. Design/methodology/approach: The methodology is an extension of the Johansen cointegration methodology based on the ‘long-run structural modelling of Pesaran and Shin (Econometric Reviews 2002). Findings: The within-sample error-correction model results tend to indicate that PP prices in North West Europe appear to have been driven by the movements in upstream prices, namely propylene, naphtha and crude oil. In contrast to the above, PP prices in the Far East appear to have been driven by downstream demand where PP is used in various automotive, building and construction, industrial and household products. Research limitations/implications: Further research into the price dynamics can be tested by looking at any asymmetric effects between upstream and downstream movements in PP value chain. Since propylene is also used as an input in the gasoline market the influence of prices in these markets needs investigating. Practical and Social implications: The dynamics is important to PP producers and consumers as they are better able to gauge if the relationship is stronger between immediate feedstocks or further upstream prices.2 page(s

Neurosciences : the next frontier of behavioral accounting?

5 page(s

Do stock prices play a significant role in formulating monetary policy? : a case study

The recent fluctuations in stock prices around the world and the critical place that the demand function for money holds in the formulation of a country’s monetary policy motivated us to investigate the question as to whether real stock prices play any significant role in affecting the demand for money and hence monetary policy. Using Australia as a case study we subject the Australian money demand function (containing real money, interest rates, real income, and real stock prices) to a rigorous econometric scrutiny. The methods applied extend the well established cointegration and error-correction framework by analyzing the out of sample properties via generalized variance decompositions, generalized impulse response and persistence profile functions. We also apply the most recently developed technique of ‘long run structural modelling’ (Pesaran and Shin, Econometric Reviews, 2002) which by imposing exactly identifying and overidentifying restrictions on the cointegrating vector has taken care of a major limitation of the conventional cointegrating estimates in that they were atheoretical in nature. We investigate the positive income effects and negative substitution effects of stock prices on money by using short and long form of interest rates together with a narrow and broad definition of money. Our results tend to indicate that stock prices do play a significant role in the money demand function. A clear policy implication is that a failure to incorporate real stock prices in the money demand function may result in the function being unstable and the monetary policy being far less effective.30 page(s

The Consumption-based capital asset-pricing model (CCAPM), habit-based consumption and the equity premium in an Australian context

We adopt the habit utility specification of Campbell and Cochrane (1995) to estimate the Australian equity premium: the return on a market portfolio of equities in excess of the risk-free rate. We use Australian quarterly data for private household consumption, population, equity returns, risk-free asset returns, dividend yields and price dividend ratios taken from Datastream International™ over a 28-year period from January 1973 to June 2002 providing 118 observations. A habit utility specification is able to reproduce an equity premium that is comparable to the actual equity premium. A variance ratio test rejected the hypothesis that the variance of estimates of the habit based Arrow-Debreu equity asset prices were the same as these based on estimates using CRRA to assess volatility or on the Hansen-Jagannathan lower bound. The habit model is able to account for more of the variability in equity prices than the CRRA model. The smooth consumption puzzle is not as severe in the Australian context when the habit model is applied to this data set. However, the habit model still does not completely resolve the equity premium puzzle in an Australian context - stock volatility is still too high compared to consumption volatility and the coefficient of risk aversion is unreasonable.19 page(s

A Practical guide for non-financial companies when modeling longer-term currency and commodity exposures

12 page(s

Price dynamics of crude oil and the regional ethylene markets

This paper is the first attempt to investigate: (i) is the crude oil (WTI) price significantly related to the regional ethylene prices in the Naphtha intensive ethylene markets of the Far East, North West Europe, and the Mediterranean? (ii) What drives the regional ethylene prices? The paper is motivated by the recent and growing debate on the lead-lag relationship between crude oil and ethylene prices. Our findings, based on the long-run structural modelling approach of Pesaran and Shin, and subject to the limitations of the study, tend to suggest: (i) crude oil (WTI) price is cointegrated with the regional ethylene prices (ii) our within-sample error-correction model results tend to indicate that although the ethylene prices in North West Europe and the Mediterranean were weakly endogenous, the Far East ethylene price was weakly exogenous both in the short and long term. These results are consistent, during most of the period under review (2000.1–2006.4) with the surge in demand for ethylene throughout the Far East, particularly in China and South Korea. However, during the post-sample forecast period as evidenced in our variance decompositions analysis, the emergence of WTI as a leading player as well, is consistent with the recent surge in WTI price (fuelled mainly, among others, by the strong hedging activities in the WTI futures/options and refining tightness) reflecting the growing importance of input cost in determining the dynamic interactions of input and product prices.10 page(s

Oil price volatility and stock price fluctuations in an emerging market : evidence from South Korea

How important are oil price fluctuations and oil price volatility on equity market performance? What are the policy implications if volatility turns out to be significant? We assess this issue in an economics/finance nexus for Korea using a VEC model including interest rates, economic activity, real stock returns, real oil prices and oil price volatility. Our main aim is to capture the effects of crude oil prices on the Korean economy thoroughly covering the period of the Asian Financial Crisis of 1997, which heavily affected the country, and the oil price hikes in the early 1990s after the Gulf War. South Korea was the country most hit by the financial crisis together with Indonesia and Thailand. Results indicate the dominance of oil price volatility on real stock returns and emphasize how this has increased over time. Oil price volatility can have profound effect on the time horizon of investment and firms need adjust their risk management procedures accordingly. This increase in dependency has been found in other net oil importing emerging equity markets. We test the relationship between oil price movements and economic activity by using modern time series techniques in a cointegrating framework. We expand the standard error correction model by examining the dynamics of out of sample causality through the generalized variance decomposition and impulse response function techniques. The evidence from persistence profiles also gives important guidelines based on how fast the entire system adjusts back to equilibrium. In addition, we find the cointegrating relationship to be stable and find that the linear error correction model to be more favorable than an asymmetric 2 period Markov switching model.12 page(s

Does the ‘Environmental Kuznets Curve’ exist? An Application of long-run structural modelling to Saudi Arabia

This study examines the relationship between income and CO2 emission on a per capita basis in Saudi Arabia during 1975-2003. It is motivated by the recent heightened world concern over global warming pollution which resulted in the formulation of the Kyoto protocol and its rapid ratification by a majority of countries in the late 1990s. There have been many attempts to explain the increase in per capita CO2 emission by relating it to per capita income growth in a country via the ‘Environmental Kuznets Curve’ (EKC). The curve is named after Kuznets (1955) who hypothesized that income inequality in a country first rises and then falls as economic growth progresses. The EKC is usually postulated to have an inverted-U shape, which means that per capita income growth is initially associated with an increase in per capita CO2 emission. However, beyond a certain point, the relationship reverses and further per capita income growth is associated with a decrease in per capita CO2 emission. The practical implication of an EKC with inverted-U shape is that a continued increase of per capita income alone would ultimately reduce per capita CO2 emission, thus obviating the need for proactive political intervention. In contrast to the above, our study, based on a recently developed rigorous time series technique known as the Long Run Structural MODELLING (LRSM) (Pesaran and Shin, Econometric Reviews, 2002), indicates that at least in the context of Saudi Arabia (1975-2003) the EKC possesses a cubic-N shape. This implies that although increasing per capita income may indeed be associated with decreasing per capita CO2 emission for a certain period, in the long run the trend will reverse and it will again be associated with increasing per capita CO2 emission. This empirical finding of our study has a significant policy implication in that increases in per capita income alone are not enough to reduce per capita CO2 emission, but should be supported by a proactive industrial/technological policy that tackles related causes and also, since CO2 emission is evidenced to be mainly income-driven, policies should be focused on environment-friendly GDP growth. Moreover, not only the production but also the consumption of GDP, in particular the tastes and preferences of high-income individuals need to be environment-friendly. These findings have profound policy implications for both the developing and the developed economies of the world.25 page(s

Price dynamics of crude oil and the regional ethylene markets

This paper is the first attempt to investigate: (i) is the crude oil (WTI) price significantly related to the regional ethylene prices in the Naphtha intensive ethylene markets of the Far East, North West Europe, and the Mediterranean? (ii) What drives the regional ethylene prices? The paper is motivated by the recent and growing debate on the lead-lag relationship between crude oil and ethylene prices. Our findings, based on the long-run structural modelling approach of Pesaran and Shin, and subject to the limitations of the study, tend to suggest: (i) crude oil (WTI) price is cointegrated with the regional ethylene prices (ii) our within-sample error-correction model results tend to indicate that although the ethylene prices in North West Europe and the Mediterranean were weakly endogenous, the Far East ethylene price was weakly exogenous both in the short and long term. These results are consistent, during most of the period under review (2000.1-2006.4) with the surge in demand for ethylene throughout the Far East, particularly in China and South Korea. However, during the post-sample forecast period as evidenced in our variance decompositions analysis, the emergence of WTI as a leading player as well, is consistent with the recent surge in WTI price (fuelled mainly, among others, by the strong hedging activities in the WTI futures/options and refining tightness) reflecting the growing importance of input cost in determining the dynamic interactions of input and product prices.Crude oil prices Petrochemical prices Ethylene prices Price dynamics Long Run Structural Modelling (LRSM)