This paper exploits the unique experimental setting created by nearly 1,300 new single stock futures listings on the OneChicago exchange between 2003 and 2009, to investigate the impact of derivatives introductions on the tightness of short sale constraints facing their underlying assets. After controlling explicitly for supply and demand conditions in the stock lending market, this experiment reveals a precipitous decline in active utilization rates and loan fees in the lending market, after the futures introductions. The paper provides strong evidence supporting the view that derivatives represent a viable alternative synthetic short selling venue relaxing short sale constraints facing their underlying assets.
Lewellen and Nagel (2006) propose that, in conditional affine factor models, the estimated risk prices should satisfy certain unconditional constraints. We test this proposition on two different types of conditional factor models and results show that the proposition only applies to the conditional models with time-varying betas. Also, from the functional relationship between conditional and unconditional betas, we identify an unconditional constraint on unconditional betas for time-varying beta models and develop a testing procedure to incorporate this unconditional constraint. We show that imposing this unconditional constraint changes estimates of unconditional betas and risk prices significantly.
The literature widely documents the negative liquidity impact of foreign participation in firms that permit high foreign institutional ownership. This paper employs a unique setting for the limited participation of qualified foreign institutional investors (QFIIs) in China’s A-share market and examines how this impacts on stock liquidity in emerging markets. Contrary to the findings in the literature, foreign investor participation helps enhance the liquidity of affected stocks by promoting trade activities and price discovery. The improvement in liquidity does not occur through the information friction channel, but rather the real friction channel. Our results are robust to endogeneity issue and the possible influence of the global financial crisis, industry effects and the stock exchange. Further, the liquidity improving effects of QFII are even stronger when the analysis is performed on a subsample of QFII firms.
We investigate how new information impacts quote clustering in the bond market. We find that clustering, along with quote activity, price volatility and bid-ask spreads, increases sharply in the minutes following releases of macroeconomic news. Each returns to near-normal levels within the hour. Effects are strongest for more liquid on-the-run notes and for the announcements typically associated with substantial information flow. The strong positive co-movement of clustering, quote activity, price volatility and bid-ask spreads supports the conclusion that innovations of these variables are endogenous to the arrival and incorporation of information into prices.
Recent literature suggests that optimal asset allocation models struggle to consistently outperform the 1/N naïve diversification strategy, which highlights estimation-risk concerns. We propose a dichotomous classification of asset-allocation models based on which elements of the inverse covariance matrix that a model uses: diagonal-only vs. full-matrix. We argue that parsimonious diagonal-only strategies, that use limited information such as volatility or idiosyncratic volatility, are likely to offer a good tradeoff between incorporating limited information while mitigating estimation risk. Evaluating five sets of portfolios over 1926-2012, we find that 1/N is generally not optimal when compared with these diagonal strategies.
In this paper, we extend the Epstein and Zin (1989, 1991) model with liquidity risk and assess the extended model’s performance against the traditional consumption pricing models. We show that liquidity is a significant risk factor, and it adds considerable explanatory power to the model. The liquidity-extended model produces both a higher cross-sectional R2 and a smaller Hansen and Jagannathan (1997) distance than the traditional consumption-based capital asset pricing model (CCAPM) and the original Epstein–Zin model. Overall, we show that liquidity is both a priced factor and a key contributor to the extended Epstein–Zin model’s goodness-of-fit.
We study the determinants of fails-to-deliver in the period before and after the implementation of Rule 203 (elimination of option market maker exception from the locate and close-out requirement) and Rule 204 (t+3 close-out rule) in September 2008. We find a positive relationship between short selling and fails-to-deliver that weakens after the implementation of these rules. Fails-to-deliver are higher for stocks with low institutional ownership, low book to market, small market capitalization, high turnover, and put option availability. The relationship between short selling and these measures of borrowing costs is also weaker after the implementation of these rules.
We use the standard geometric Brownian motion augmented by jumps to describe the spot underlying and mean regressive models of interest rates and convenience yields as state variables for gold and copper prices. Estimates of parameters of the diffusion processes are obtained by the Kalman filter. Using these estimates, jump parameters are estimated in the second stage by least squares. Early exercise premia on puts and calls are computed using a lattice with probabilities assigned by the density matching technique. We find that while deep in the money options have greater absolute early exercise premiums, the early exercise premium is roughly constant as a percent of option price. Our findings also confirm that gold behaves like an investment asset and copper behaves like a commodity.