Information processing and measures of integration: New York, London and Tokyo

Equity markets do not pass all overnight information into prices instantaneously at the opening of trade. The New York market takes up to 30 minutes after the opening time to absorb overnight foreign news, Tokyo takes about 90 minutes, and London about 120 minutes on average. These delays in information absorption are not commercially significant but do have implications for measures of market integration. We adjust intra-daily return series for non-instantaneous news absorption and then use adjusted series to predict opening price variation in three major equity markets. Because the adjusted daytime returns series are uncorrelated, we can accurately measure the size, and identify the sources, of transmissions. Overnight news, as represented by foreign daytime returns, explains 12% of opening price variation (close-open returns) in New York, 14% in Tokyo and 30% in London. For New York and Tokyo, the largest influences come from the market that trades immediately prior (London and New York respectively) whereas opening price variation in London is linked closer with New York than Tokyo. Foreign volatility spillovers are also significant, and subject to asymmetry effects.GARCH; spillover; integration; transmission; efficiency

Crude Oil Volatility: Hedgers or Investors

We evaluate differential effects of the trading activity of two classes of traders: hedgers and general investors, on the volatility of the NYMEX crude oil futures returns. It appears that the rebalancing activity of oil hedgers has a significant and positive effect on the oil futures volatility. On the other hand, non-commercial players (investors) who take positions in the crude oil futures as well as stocks and bonds do not affect the crude oil volatility significantly by rebalancing their positions.Crude Oil Futures Volatility, Optimal Portfolio Weight, Hedge Ratio, GARCH, Time-Series, Effects of Investors and Hedgers

Valuing Volatility Spillovers

forecasting, adcc, volatility spillovers, valuing

Asymmetric Risk and International Portfolio Choice

Empirical research shows that stock volatilities and correlations between markets rise more after negative shocks than after positive returns shocks of the same size. We measure the importance of these asymmetric effects for mean-variance investors holding portfolios of international equities who use dynamic conditional covariance forecasts to reweight their portfolios. Portfolio weights are computed using ex ante predictions from symmetric GARCH DCC and asymmetric GJR ADCC models, and a spectrum of expected returns. Data are weekly returns to equity price indices for the USA, Japan, UK and Australia. We find that the majority of realised portfolio standard deviations are less when we reweight using the asymmetric covariance model. Reductions in portfolio risk are significant according to Diebold-Mariano tests. Investors who are moderately risk averse and have longer rebalancing horizons benefit more from the asymmetric model than less risk averse, shorter-horizon investors, and would be prepared to pay up to 107 basis points annually to use it instead of the symmetric model. Benefits are greater for investors holding US equities.

Temporal links between the Asia-Pacific and international stock markets: 1971-2010

I examine interdependencies between the national stock markets of the US, the UK, Japan and Australia, and consider their implications for international portfolio diversification over the 1971-2010 time period. It appears that the risk- reduction benefits associated with diversification across the Anglo-American markets have steadily declined since 1993, while the diversification gains of investing in Japanese equities began diminishing around 2001, when the correlations between Japan and the other three markets commenced an upward trend. Like volatility, all conditional correlations increase in magnitude when associated with bear markets. It seems that international diversification fails to provide risk-protection when it is needed the most, during periods of financial distress.9 page(s

Size-sorted portfolios and information spillovers: structural evidence from Australia

A structural model is proposed to analyze linkages between large, medium and small capitalization securities traded on the Australian Stock Exchange. Small stocks fail to react instantaneously to the information transmitted by large and medium cap firms, and take several weeks to absorb this information in an entirely lagged adjustment process. In contrast, medium firms respond to the information conveyed by large cap securities with about 80 percent instantaneous and 20 percent lagged adjustment. Large stocks are the quickest to respond to new information but slightly overshoot in their immediate reaction to the news transmitted by medium cap firms. A number of trading strategies are constructed on the basis of the uncovered patterns in order to test for the possibility of arbitrage profits. Although the excess returns generated by these strategies are typically positive, they are statistically insignificant, suggesting that the discovered signals are too weak to be successfully used for trading purposes.9 page(s

Testing for Identification in SVAR-GARCH Models: Reconsidering the Impact of Monetary Shocks on Exchange Rates

Changes in residual volatility in vector autoregressive (VAR) models can be used for identifying structural shocks in a structural VAR analysis. Testable conditions are given for full identification for the case where the volatility changes can be modelled by a multivariate GARCH process. Formal statistical tests are presented for identification and their small sample properties are investigated via a Monte Carlo study. The tests are applied to investigate the validity of the identification conditions in a study of the effects of U.S. monetary policy on exchange rates. It is found that the data do not support full identification in most of the models considered, and the implied problems for the interpretation of the results are discussed