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Federal Reserve Bank of St. Louis working papers are preliminary materials circulated to stimulate discussion and critial comment.

Finance

The Dynamic Interaction of Trading Flows, Macroeconomic Announcements and the CAD/USD Exchange Rate: Evidence from Disaggregated Data

We explore the relationship between disaggregated trading flows, the Canada/U.S. dollar (CAD/USD) market and U.S. macroeconomic announcements with a novel data set of unprecedented breadth and length. <a href="http://research.stlouisfed.org/econ/cneely/Data_Appendix_The_Dynamic_Interaction.pdf">Data Appendix</a>.

Equity Portfolio Diversification under Time-Varying Predictability and Comovements: Evidence from Ireland, the US, and the UK

We use multivariate regime switching vector autoregressive models to characterize the time-varying linkages among short-term interest rates (monetary policy) and stock returns in the Irish, the US and UK markets.

The Microstructure of the U.S. Treasury Market

This article discusses the microstructure of the U.S. Treasury securities market. Treasury securities are nominally riskless debt instruments issued by the U.S. government.

Lending to Uncreditworthy Borrowers

We study optimal lending behavior under adverse selection in environments with hetero- geneous borrowers— specifically, where the borrower’s reservation payoffs (outside options) increase with quality (creditworthiness).

Accounting for Changes in the Homeownership Rate

After three decades of being relatively constant, the homeownership rate increased over the period 1994 to 2005 to attain record highs.

Jumps, Cojumps and Macro Announcements

We use recently proposed tests to extract jumps and cojumps from three types of assets: stock index futures, bond futures, and exchange rates. We then characterize the dynamics of these discontinuities and informally relate them to U.S. macroeconomic releases before using limited dependent variable models to formally model how news surprises explain (co)jumps.

Managing International Portfolios with Small Capitalization Stocks

In the context of an international portfolio diversification problem, we find that small capitalization equity portfolios become riskier in bear markets, i.e. display negative co-skewness with other stock indices and high co-kurtosis. Because of this feature, a power utility investor ought to hold a well-diversified portfolio, despite the high risk premium and Sharpe ratios offered by small capitalization stocks.

Monetary Policy and Stock Market Booms and Busts in the 20th Century

This paper examines the association between monetary policy and stock market booms and busts in the United States, United Kingdom, and Germany during the 20th century.

Multivariate Contemporaneous Threshold Autoregressive Models

In this paper we propose a contemporaneous threshold multivariate smooth transition autoregressive (C-MSTAR) model in which the regime weights depend on the ex ante probabilities that latent regime-specific variables exceed certain threshold values.

Affiliated Mutual Funds and Analyst Optimism

Prior studies have shown that investment banking affiliations place pressure on analysts to produce optimistic recommendations on the investment bank’s stock-clients.

Mean-Variance vs. Full-Scale Optimization: Broad Evidence for the UK

Portfolio choice by full-scale optimization applies the empirical return distribution to a parameterized utility function, and the maximum is found through numerical optimization.

The Expectation Hypothesis of the Term Structure of Very Short-Term Rates: Statistical Tests and Economic Value

This paper re-examines the validity of the Expectation Hypothesis (EH) of the term structure of US repo rates ranging in maturity from overnight to three months.

The Economic and Statistical Value of Forecast Combinations under Regime Switching: An Application to Predictable US Returns

We address one interesting case — the predictability of excess US asset returns from macroeconomic factors within a flexible regime switching VAR framework — in which the presence of regimes may lead to superior forecasting performance from forecast combinations.

When Do Stock Market Booms Occur? The Macroeconomic and Policy Environments of 20th Century Booms

This paper studies the macroeconomic conditions and policy environments under which stock market booms occurred among ten developed countries during the 20th Century.

Does Aggregate Relative Risk Aversion Change Countercyclically over Time? Evidence from the Stock Market

Using a semiparametric estimation technique, we show that the risk-return tradeoff and the Sharpe ratio of the stock market increases monotonically with the consumption wealth ratio (CAY) across time.

The Adaptive Markets Hypothesis: Evidence from the Foreign Exchange Market

We analyze the intertemporal stability of excess returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously studied rules.

Corporate Response to Distress: Evidence from the Asian Financial Crisis

This paper provides a comprehensive examination of the ways in which companies respond to a country-wide crisis through the restructuring of their assets (through asset sales, mergers or liquidations) or liabilities. We find the restructuring of liabilities to be the most common type of response.

The Termination of Subprime Hybrid and Fixed Rate Mortgages

Adjustable rate and hybrid loans have been a large and important component of subprime lending in the mortgage market. While maintaining the familiar 30-year term the typical adjustable rate loan in subprime is designed as a hybrid of fixed and adjustable characteristics.

The Relation between Time-Series and Cross-Sectional Effects of Idiosyncratic Variance on Stock Returns in G7 Countries

This paper suggests that CAPM-based idiosyncratic variance (IV) correlates negatively with future stock returns because it is a proxy for loadings on discount-rate shocks in Campbell’s (1993) ICAPM. The ICAPM also implies that there are important links between the time-series and cross-sectional IV effects.

Why Do Analysts Continue to Provide Favorable Coverage for Seasoned Stocks?

Research has documented that the first report an investment bank affiliated analyst issues on a newly listed stock tends to be favorable. Our analysis of 16,824 relationships between analyst teams and established listed companies during 1995-2003 indicates that analyst coverage decisions of seasoned stocks are influenced by their affiliations with investment banks and mutual funds.

Central Bank Intervention with Limited Arbitrage

Shleifer and Vishny (1997) pointed out some of the practical and theoretical problems associated with assuming that rational risk-arbitrage would quickly drive asset prices back to long-run equilibrium.

Central Bank Intervention and Exchange Rate Volatility, Its Continuous and Jump Components

We analyze the relationship between interventions and volatility at daily and intra-daily frequencies for the two major exchange rate markets.

What Tames the Celtic Tiger? Portfolio Implications from a Multivariate Markov Switching Model

We use multivariate regime switching vector autoregressive models to characterize the time-varying linkages among the Irish stock market, one of the top world performers of the 1990s, and the US and UK stock markets.

Investing for the Long-Run in European Real Estate

We calculate optimal portfolio choices for a long-horizon, risk-averse investor who diversifies among European stocks, bonds, real estate, and cash, when excess asset returns are predictable. Simulations are performed for scenarios involving different risk aversion levels, horizons, and statistical models capturing predictability in risk premia. Importantly, under one of the scenarios, the investor takes into account the parameter uncertainty implied by the use of estimated coefficients to characterize predictability.

The Duration of Foreclosures in the Subprime Mortgage Market: A Competing Risks Model with Mixing

This paper examines what happens to mortgages in the subprime mortgage market once foreclosure proceeding are initiated. A multinominial logit model that allows for the interdependence of the possible outcomes or risks (cure, partial cure, paid off, and real estate owned) through the correlation of associated unobserved heterogeneities is estimated.

Loan Servicer Heterogeneity and The Termination of Subprime Mortgages

After a mortgage is originated the borrower promises to make scheduled payments to repay the loan. These payments are sent to the loan servicer, who may be the original lender or some other firm. This firm collects the promised payments and distributes the cash flow (payments) to the appropriate investor/lender.

Subprime Refinancing: Equity Extraction and Mortgage Termination

This paper examines the choice of borrowers to extract wealth from housing in the high-cost (subprime) segment of the mortgage market while refinancing and assesses the prepayment and default performance of these cash-out refinance loans relative to the rate refinance loans.

Predatory Lending Laws and the Cost of Credit

Various states and other local jurisdictions have enacted laws intending to reduce predatory and abusive lending in the subprime mortgage market. These laws have created substantial geographic variation in the regulation of mortgage credit. This paper examines whether these laws are associated with a higher or lower cost of credit.

Understanding Stock Return Predictability

Over the period 1927:Q1 to 2005:Q4, the average CAPM-based idiosyncratic variance (IV) and stock market variance jointly forecast stock market returns.

Why People Choose Negative Expected Return Assets - An Empirical Examination of a Utility Theoretic Explanation

Using a theoretical extension of the Friedman and Savage (1948) utility function developed in Bhattacharyya (2003), we predict that for financial assets with negative expected returns, expected return will be a declining and convex function of skewness. Using a sample of U.S. state lottery games, we find that our theoretical conclusions are supported by the data.


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