The contagion effects of sovereign downgrades: evidence from the European financial crisis

This research examines the effects of sovereign downgrades on European financial markets between 2005 and 2012. Vector Autoregression (VAR) techniques are used to investigate the presence of contagion effects after a sovereign downgrade across equity indices, five year Credit Default Swaps (CDS) and ten year government bonds of the investigated European states. Sovereign downgrades are found to be associated with an increase in equity returns, and cause significant increases in the cost of insuring debt through CDS and the yield of government debt. The Greek and Irish downgrades are to found to have significant reverberations throughout European financial markets. German CDS spreads are found to increase when a European state is downgraded, signalling their use by investors as a barometer of European-wide defaults. Though credit rating agencies clearly missed the European sovereign crisis prior to 2007, their rating downgrades are still found to cause significant effects within European financial markets

Quantifying the effects of new derivative introduction on exchange volatility, efficiency and liquidity

This thesis investigates the effects of the introduction of new financial derivative products on exchange volatility, efficiency and liquidity. The derivatives under primary investigation are Exchange Traded Funds (ETFs) and Contracts for Difference (CFDs). These products offer a cheap, tax-efficient and speedy method for increasing or decreasing market exposure to price changes in the related primary asset. By facilitating faster and shorter-term trading, these products may increase market liquidity and/or increase market volatility for the related primary asset. The thesis builds a cross-country database of new-derivative-markets opening dates, and investigates the key features of prices and returns for related primary assets before and after the opening of these derivative markets. The database covers 16 countries in the CFD investigation, 21 commodity markets in the ETF investigation, and related data as available (daily closing prices, trading volumes, bid-ask quotes) in each of them. The key price and return features investigated include bid-ask spreads, trading volumes (both of derivatives and related primary assets), and daily return autocorrelation, variance, skewness and kurtosis. This thesis also considers a separate, but related, research problem. It extends and empirically applies a liquidity-indicator model for the Eurozone created by the Bank of England (BOE) and developed further by the European Central Bank (ECB) by including commodity liquidity, and uses this extended model to investigate shifting investor behaviour based on changing market dynamics. Similar to the investigation of the CDF and EFT markets, this investigation is concerned with market stability and liquidity in a changed environment (in this case, the key change is the introduction of the euro currency). Chapter one contains an introduction to the main hypotheses regarding the effects of the introduction of new derivatives on securities markets, and the empirical methods used to test these hypotheses. This chapter also describes the two investment products which are the main focus, CFDs and ETFs, and their particular potential impacts on market-specific characteristics such as volatility, efficiency and liquidity. Chapter two empirically investigates the impact of CFDs on market liquidity and volatility. CFDs have existed for less than twenty years and the CFD market grew rapidly prior to the recent international financial crisis. This chapter empirically examines the roles that CFDs have played, either as an accelerant for mispricing in international equity markets away from fundamental values, or as a source of increased market efficiency through the addition of new liquidity. This chapter uses GARCH and EGARCH models to test for the impact of CFDs on the return volatility and autocorrelation of the underlying security. In the case of Australia, the analysis is applied to individual securities. In the other 15 countries investigated in this chapter, the analysis is applied at the level of the market index. The chapter also investigates whether the stylised characteristics of CFDs are more or less pronounced in low liquidity exchanges. This chapter finds that CFDs appear to have influenced asset-specific variance and return autocorrelation. Some tentative explanations for these findings are offered. The presence of bid and ask-price ‘overhangs’ associated with CFD trading cannot be rejected and may be associated with observed volatility reductions in some jurisdictions. Following the analysis based on CFDs in chapter two, ETFs are the primary focus of chapter three. ETFs have existed since the late 1980s, but were first traded on commodity markets in the early 2000s. Their inception has been linked by some market analysts with the large growth in commodity market volatility seen in recent years. This chapter directly tests this link. The chapter also investigates whether the stylised characteristics of ETFs are more or less pronounced in larger commodity markets than in smaller markets. The results indicate that larger ETFs in terms of their assets under management at their dates of inception, are associated with higher volatility. Smaller commodity markets are found to have increased efficiency after the introduction of ETFs, indicating that there are some benefits from new ETF investment in markets below $4 to$5 billion in size, but the associated caveat is that of increased volatility, indicative of potential pitfalls in the ETF portfolio rebalancing process. It appears that ETFs have made commodity markets more efficient through a new influx of trading counterparties, but they appear to be associated with a cost. The need for regulation of investment size and market ownership limits therefore cannot be rejected. Chapters two and three look at two particular new instruments and their effects on liquidity and volatility. Another major innovation in market structure was the advent of the euro currency in January 1999. The power and presence of a financially-combined Europe attracted new international investment, therefore influencing liquidity. The combination of this influx of investors and new products (including CFDs and ETFs) can potentially have wide market impacts. Understanding the structural changes of liquidity in Europe in recent years is important for macroprudential risk assessment, as sudden changes in conditions may be indicative of current stress and a signal of future stress. Chapter four presents a Europeanspecific liquidity measure used by several central banks, and provides some new modifications to this measure. The measure is constructed by combining several facets of liquidity and depth measurement across several asset markets. It attempts to incorporate aspects such as market tightness, depth and resiliency. The flows and the direction of causality can also be inferred using vector autoregression, Granger causality techniques and impulse response functions. The measure uses a combination of liquidity determinants including the bid-ask spread, the return to volume ratio and numerous measures of liquidity premia. In the chapter, the modified liquidity measure is applied empirically to European-area data

Quantifying the effects of new derivative introduction on exchange volatility, efficiency and liquidity

This thesis investigates the effects of the introduction of new financial derivative products on exchange volatility, efficiency and liquidity. The derivatives under primary investigation are Exchange Traded Funds (ETFs) and Contracts for Difference (CFDs). These products offer a cheap, tax-efficient and speedy method for increasing or decreasing market exposure to price changes in the related primary asset. By facilitating faster and shorter-term trading, these products may increase market liquidity and/or increase market volatility for the related primary asset. The thesis builds a cross-country database of new-derivative-markets opening dates, and investigates the key features of prices and returns for related primary assets before and after the opening of these derivative markets. The database covers 16 countries in the CFD investigation, 21 commodity markets in the ETF investigation, and related data as available (daily closing prices, trading volumes, bid-ask quotes) in each of them. The key price and return features investigated include bid-ask spreads, trading volumes (both of derivatives and related primary assets), and daily return autocorrelation, variance, skewness and kurtosis. This thesis also considers a separate, but related, research problem. It extends and empirically applies a liquidity-indicator model for the Eurozone created by the Bank of England (BOE) and developed further by the European Central Bank (ECB) by including commodity liquidity, and uses this extended model to investigate shifting investor behaviour based on changing market dynamics. Similar to the investigation of the CDF and EFT markets, this investigation is concerned with market stability and liquidity in a changed environment (in this case, the key change is the introduction of the euro currency). Chapter one contains an introduction to the main hypotheses regarding the effects of the introduction of new derivatives on securities markets, and the empirical methods used to test these hypotheses. This chapter also describes the two investment products which are the main focus, CFDs and ETFs, and their particular potential impacts on market-specific characteristics such as volatility, efficiency and liquidity. Chapter two empirically investigates the impact of CFDs on market liquidity and volatility. CFDs have existed for less than twenty years and the CFD market grew rapidly prior to the recent international financial crisis. This chapter empirically examines the roles that CFDs have played, either as an accelerant for mispricing in international equity markets away from fundamental values, or as a source of increased market efficiency through the addition of new liquidity. This chapter uses GARCH and EGARCH models to test for the impact of CFDs on the return volatility and autocorrelation of the underlying security. In the case of Australia, the analysis is applied to individual securities. In the other 15 countries investigated in this chapter, the analysis is applied at the level of the market index. The chapter also investigates whether the stylised characteristics of CFDs are more or less pronounced in low liquidity exchanges. This chapter finds that CFDs appear to have influenced asset-specific variance and return autocorrelation. Some tentative explanations for these findings are offered. The presence of bid and ask-price ‘overhangs’ associated with CFD trading cannot be rejected and may be associated with observed volatility reductions in some jurisdictions. Following the analysis based on CFDs in chapter two, ETFs are the primary focus of chapter three. ETFs have existed since the late 1980s, but were first traded on commodity markets in the early 2000s. Their inception has been linked by some market analysts with the large growth in commodity market volatility seen in recent years. This chapter directly tests this link. The chapter also investigates whether the stylised characteristics of ETFs are more or less pronounced in larger commodity markets than in smaller markets. The results indicate that larger ETFs in terms of their assets under management at their dates of inception, are associated with higher volatility. Smaller commodity markets are found to have increased efficiency after the introduction of ETFs, indicating that there are some benefits from new ETF investment in markets below $4 to$5 billion in size, but the associated caveat is that of increased volatility, indicative of potential pitfalls in the ETF portfolio rebalancing process. It appears that ETFs have made commodity markets more efficient through a new influx of trading counterparties, but they appear to be associated with a cost. The need for regulation of investment size and market ownership limits therefore cannot be rejected. Chapters two and three look at two particular new instruments and their effects on liquidity and volatility. Another major innovation in market structure was the advent of the euro currency in January 1999. The power and presence of a financially-combined Europe attracted new international investment, therefore influencing liquidity. The combination of this influx of investors and new products (including CFDs and ETFs) can potentially have wide market impacts. Understanding the structural changes of liquidity in Europe in recent years is important for macroprudential risk assessment, as sudden changes in conditions may be indicative of current stress and a signal of future stress. Chapter four presents a Europeanspecific liquidity measure used by several central banks, and provides some new modifications to this measure. The measure is constructed by combining several facets of liquidity and depth measurement across several asset markets. It attempts to incorporate aspects such as market tightness, depth and resiliency. The flows and the direction of causality can also be inferred using vector autoregression, Granger causality techniques and impulse response functions. The measure uses a combination of liquidity determinants including the bid-ask spread, the return to volume ratio and numerous measures of liquidity premia. In the chapter, the modified liquidity measure is applied empirically to European-area data

Hacking the market: Systemic contagion from cybersecurity breaches

The average stock market reaction in the 10 days after a cyber attack has become increasingly negative, write Constantin Gurdgiev and Shaen Corbe

The contagion effects of the COVID-19 pandemic:Evidence from gold and cryptocurrencies

At the beginning of the 2020 global COVID-2019 pandemic, Chinese financial markets acted as the epicentre of both physical and financial contagion. Our results indicate that a number of characteristics expected during a "flight to safety" were present during the period analysed. The volatility relationship between the main Chinese stock markets and Bitcoin evolved significantly during this period of enormous financial stress. We provide a number of observations as to why this situation occurred. Such dynamic correlations during periods of stress present further evidence to cautiously support the validity of the development of this new financial product within mainstream portfolio design through the diversification benefits provided

The differential impact of corporate blockchain-development as conditioned by sentiment and financial desperation

This paper investigates how companies can utilise Twitter social media-derived sentiment as a method of generating short-term corporate value from statements based on initiated blockchain-development. Results indicate that investors were subjected to a very sophisticated form of asymmetric information designed to propel sentiment and market euphoria, that translates into increased access to leverage on the part of speculative firms. Technological-development firms are found to financially behave in a profoundly different fashion to reactionary-driven firms which have no background in ICT technological development, and who experience an estimated increased one-year probability of default of 170bps. Rating agencies are found to have under-estimated the risk onboarded by these speculative firms, failing to identify that they should be placed under an increased degree of scrutiny. Unfiltered market sentiment information, regulatory unpreparedness and mispricing by trusted market observers has resulted in a situation where investors and lenders have been compromised by direct exposure to an asset class becoming known for law-breaking activity, financial losses and frequent reputational damage

Public accountability and parliamentary scrutiny in finance

The purpose of parliament is to present a discussion of policy in a fashion that will bring about a consensus that results in collective action. Such a collective action serves the common good of the state, although second-order effects and Pareto optimality is difficult to obtain, if not impossible. Parliament attempts to address the second-best world in a socially optimal fashion. As such accountability and scrutiny are the key tools through which such a body can address the challenges faced by a financial sector faced with profound difficulties. Such accountability is of paramount importance to provide sustainable public trust in parliament

Sustainability, accountability and democracy: Ireland’s Troika experience

Sustainability in the public finances. This was the mantra of the IMF-ECB-EC Troika bailout. How was sustainability achieved? Mainly by changing aspects of the budgetary process. Ireland was required to submit the entirety of its budgetary framework for external scrutiny by the Troika and Eurozone member state governments. We briefly explore how the economic constitution of the European Union in the context of the Irish bailout turned macroeconomic sustainability into an instrument to redirect the majority of Irish policy decision-making out of the hands of democratically accountable parliamentarians and into the arms of unaccountable technocrats

Guilt through association:Reputational contagion and the Boeing 737-MAX disasters

The unfortunate set of circumstances surrounding the loss of both Lion Air Flight 610 and Ethiopian Airlines Flight 302 led to the immediate grounding of the advertised ‘incredibly fuel efficient’ Boeing 737-MAX. The side-effects of the decision to ground such flights led to delays and cancellation of orders. Companies with entire Boeing fleets and a heavy reliance on the proposed cost-savings in an ultra-competitive industry thereby made their shareholders aware that identified future revenue generation was now on hold indefinitely. Results indicate that investors identified this reliance, but also, the subsequent negative polarity and subjectivity of social media response is found to have significantly influenced the share price of airlines with no fleet diversification, and subsequently, no reputational diversification