Trend Following and Macroeconomic Risk

Time series momentum and macroeconomic risk

To examine the familiar tradeoff between risk and return in financial investments, we use a rolling two-stage stochastic program to compare mean-risk optimization models with time series momentum strategies. In a backtest of allocating investment between a market index and a risk-free asset, we generate scenarios of future return according to a momentum-based stochastic process model. A new hybrid approach, time series momentum strategy controlling downside risk (TSMDR), frequently dominates traditional approaches by generating trading signals according to a modified momentum measure while setting the risky asset position to control the conditional value-at-risk (CVaR) of return. For insight into the outperformance of TSMDR, we decompose each strategy into two aspects, the trading signal and the asset allocation model that determines the risky asset position. We find that 1) weighted moving average can better capture the trend of the stock market than time series momentum computed as past 12-month excess return, 2) mean-risk strategies generally provide better returns whereas risk parity strategies have less investment risk and 3) controlling CVaR limits the investment risk better than controlling variance does.

Optimality of Momentum and Reversal

Production-Based Asset Pricing and the Oil Market

This paper studies the shareholder wealth effects associated with 875 new security issues in Japan from January 1, 1985 to May 31, 1991. The sample includes public equity, private equity, rights offerings, straight debt, warrant debt and convertible debt issues. Contrary to the U.S., the announcement of convertible debt issues is accompanied by a significant positive abnormal return of 1.05%. The announcement of equity issues has a positive abnormal return ofO.45%, significant at the 0.10 level, but this positive abnormal return can be attributed to one year in our sample and is offset by a negative issue date abnormal return of -1.01%. The abnormal returns are negatively related to firm size, so that for equity issues (but not for convertible debt issues), large Japanese firms have significant negative announcement abnormal returns. Our evidence is consistent with the view that Japanese managers decide to issue shares based on different considerations than American managers.

The three essays in this dissertation study the impact of corporate liquidity on a firm's value, how corporate liquidity affects the probability of financial distress and equity returns, and whether corporate liquidity represents an idiosyncratic risk, or serves as a priced risk factor.;The first essay examines the relationship between corporate liquidity and equity returns for individual firms. It is found that firms holding more liquid assets have significantly higher equity returns. This positive relationship between corporate liquidity and equity returns is more pronounced among firms with financial constraints. In addition, firms expecting volatile cash flows stock more cash for precautionary purposes and their stock returns are higher relative to those generating stable cash flows. These empirical evidences indicate that the level of corporate liquidity may signal risks faced by companies. Furthermore, more liquid firms tend to have higher market beta, which suggests that corporate liquidity may serve as a risk factor. Finally, Fama-MacBeth two pass regression results show that corporate liquidity contains different information than what is included in other important firm characteristics like size and book-to-market equity ratio.;The second essay further explores the relationship between corporate liquidity and the expected return of stocks at the aggregate level. Asset pricing tests are performed to examine whether the constructed corporate liquidity factor, LMI (Liquid Minus Illiquid), is a risk factor and whether it is systematic and priced. Empirical evidences from multifactor asset pricing models suggest that LMI can still serve as an independent factor and is priced although it shares some common information with the three popular factors MKT, SMB and HML. Moreover, corporate liquidity beta is increased when the macroeconomic condition becomes less favorable, and the corporate liquidity beta is more sensitive to changes in macroeconomic conditions for firms with more corporate liquidity and financial constraints.;The third essay examines how a company's market value can be affected by residual cash, and whether corporate liquidity and negative residual cash can predict bankruptcy. It is shown that deviation from the target or optimal cash is value destructive, which provides support for the tradeoff theory. However, the impact of residual cash on market value of equity is not symmetric: positive residual cash tends to reduce firm value less than negative residual cash. In general, firms with negative residual cash are more likely to experience financial distress since they are smaller, less profitable, generate lower cash flows, and have higher leverage but weaker payoff

This paper not only provides a theoretical model for the value-at-risk of active and passive trading strategies but also discusses the substantial implications relevant to risk management. Our results suggest that, first, passive strategies are riskier than active trading strategies based on historical returns, such as momentum and contrarian strategies. Second, momentum (contrarian) trading is riskier in a bull (bear) market. Third, the value-at-risk of momentum (contrarian) strategies has a positive relation to the absolute value of the return autocorrelation, as well as a positive (negative) relation with the state of the market. Further, momentum trading strategies give a superior risk-adjusted performance compared with other strategies in international stock markets.

We study China stock market using the Consumption-based Capital Asset Pricing Model (CCAPM) of Lucas [Econometrica 46 (1978) 1429]. A cointegration test reveals no long-term relationship between equity prices and dividends in China. The applicability of the CCAPM seems weak in China. The highly volatile dividend growth rates nonetheless cannot rationalize the large equity premia (the equity premium puzzle) in China stock market. We find the mean model-implied risk-free rate is much higher than the historical figure in China.

UNITED STATES nonfinancial corporations are constantly engaged in the task of ensuring the availability of the necessary flow of funds for their financial requirements. One purpose of this study is to review and present corporations' new issues by the type of instrument involved. Emphasis is placed on changes in patterns of external financing with respect to both volume and composition of new issues in various industrial classifications. Graphic representation of the data shows that wide variations in the types of external financing (i.e., bonds, common stocks, and preferred stocks) exist among the various industrial classifications. Various economic conditions and certain legal and institutional characteristics of the new issues examined cause some forms of financing to be relatively more attractive than others. Particularly, since the enactment of corporation income tax laws, it has been argued that these taxes discriminate in favor of debt capital as opposed to equity capital. Given these conditions, this dissertation is primarily concerned with developing and statistically testing a theoretical model to determine if corporations have increasingly responded to tax-created cost pressures by acquiring proportionately more debt in their capital structures as tax rates have risen. Furthermore, two hypotheses are formulated for testing; these are the relative cost hypothesis (RCH) and the equal cost hypothesis (ECH). These two hypotheses concern the manner in which corporations make the choice between a debt or an equity issue. Under the RCH, other things equal, the lower the rate of interest relative to the cost of equity capital, the greater the incentive for corporations to float bonds rather than stock, and vice versa. Alternatively, under the ECH despite the relatively lower cost of debt, the true cost of borrowed funds to the firm is, to a first approximation, essentially the same as that of equity capital when allowance is made for the implicit costs created by the risks of leverage and bankruptcy. A range of circumstances exists in which these two hypotheses yield similar empirical predictions. For example, if stock prices were rising but the level of the rate of interest and of the tax rate were unchanged, both hypotheses would predict an increase in the ratio of stocks to bonds in new flotations. To RCH advocates such action is a result of lower relative costs. Yet, to ECH supporters this action is a result of corporations meeting long-range financing plans requiring additional outside equity rather than deliberately shifting from debt to equity as implied by the RCH. Some anticipated econometric problems and cost measurement problems are considered, with particular emphasis placed on the dependent variable (the proportion of new common stock issues to total new issues) and on the cost of equity capital variable. Statistical testing of the basic multiplicative model over the 1930-1971 period

In this paper, we address the question whether the impact of default risk on equity returns depends on the financial system firms operate in. Using an implementation of Merton's option-pricing model for the value of equity to estimate firms' default risk, we construct a factor that measures the excess return of firms with low default risk over firms with high default risk. We then compare results from asset pricing tests for the German and the U.S. stock markets. Since Germany is the prime example of a bank-based financial system, where debt is supposedly a major instrument of corporate governance, we expect that a systematic default risk effect on equity returns should be more pronounced for German rather than U.S. firms. Our evidence suggests that a higher firm default risk systematically leads to lower returns in both capital markets. This contradicts some previous results for the U.S. by Vassalou/Xing (2004), but we show that their default risk factor looses its explanatory power if one includes a default risk factor measured as a factor mimicking portfolio. It further turns out that the composition of corporate debt affects equity returns in Germany. Firms' default risk sensitivities are attenuated the more a firm depends on bank debt financing.

Asset Price movements indicate financial health of an economy because of the serious affects these have on financial indicators. This study is carried out to see the behaviour of asset price movements in different time horizons in the presence of leading economic indicators. The objective of this study is to track asset price movements and the impact of economic indicators on asset prices in different time horizons. This study intends to find out the appropriate time horizon for predicting asset price buildup that can lead to a potential financial crisis. Uni-variate and Multi-variate Logit Regression Analysis is performed in this study to be applied in four different time horizons. Results show that Real Gross Domestic Product, Credit to private sector, Interest rates of Long and Short term, Gross Domestic Product-deflator, the Consumer Price Index, Real effective exchange rates and nominal effective exchange rates are the significant early warning indicators for predicting the future financial crisis in the economy of Pakistan in longer time horizon as they affect asset price buildup in the long time periods. This study shows that asset prices contain more information in long run and can be effectively used as a tool to predict financial crises due to asset price misalignments

The article discusses modern approaches to improving the management of sources of financing for the oil industry in the context of the active development of ESG transformation. The analysis of the structure and classification of capital sources has been carried out, and the main challenges associated with the integration of environmental, social and managerial factors into the financial strategy of enterprises have been identified. The impact of ESG factors on the cost of raising capital and the creditworthiness of companies, as well as the possibility of using green financial instruments and IT technologies to improve the efficiency of financial management, is assessed. The research results reveal the prospects for the formation of a balanced capital structure, taking into account sanctions restrictions and macroeconomic risks. Practical recommendations for increasing the sustainability and investment attractiveness of the oil and gas sector, contributing to the achievement of sustainable development goals, are presented. Particular attention is paid to the need to integrate ESG principles into financial planning and to build effective capital management mechanisms that minimize risks and ensure the long-term competitiveness of the industry. The possibilities of digitalization of financial processes and the use of innovative tools to adapt businesses to rapidly changing economic and environmental conditions are considered. This integrated approach contributes to the development of the oil sector in accordance with the requirements of sustainable development and current global trends.

“Rules of thumb” for sovereign debt crises

This paper examines equity return predictability using the returns of commodity futures along the supply chain in China's financial market. We find that a considerable number of commodities exhibit significant in‐sample forecasting ability at the daily horizon, especially for supplier‐side equity returns. The macroeconomic risk premium effect, captured by the aggregate commodity prices, is an important source for this predictability. The out‐of‐sample results show that for most commodities, the predictability remains both statistically and economically significant, and the forecasting performance improves substantially during recessions or with economic constraints.

Default Risk and Equity Returns: A Comparison of the Bank-Based German and the U.S. Financial System