Gioia Pescetto

Modelling International Price Relationships and Interdependencies Between the Stock Index and Stock Index Futures Markets of Three EU Countries: A Multivariate Analysis

This paper addresses the important relationship between stock index and stock index futures markets in an international context. By simply examining the spot-futures relationship within a single country as most of the extant literature does and thus ignoring possible market interdependencies between countries, the dynamics of price adjustments may be misspecified and thus findings misleading. The main contribution of the paper is to improve our understanding of the pricing relationship between spot and futures markets in the light of international market interdependencies. Using a multivariate VAR-EGARCH methodology, the paper investigates stock index and stock index futures market interdependence, that is lead-lag relationships and volatility interactions between the stock and futures markets of three main European countries, namely France, Germany and the UK. In addition, the paper explicitly accounts for potential asymmetries that may exist in the volatility transmission mechanism between these markets. The main conclusions of the paper imply that investors need to account for market interactions across countries to fully and correctly exploit the potential for hedging and diversification.

Market‐wide and sectoral integration: Evidence from the UK, USA and Europe

Purpose - The paper seeks to investigate conditional correlations and conditional volatility spillovers across international stock markets and industrial sectors from the perspective of the UK investor. Design/methodology/approach - Utilizing the DCC model, the paper extracts the time-varying conditional correlations between the UK, US and European stock markets and industrial sectors. It also uses the multivariate generalized autoregressive conditional heteroscedasticity (MVGARCH) to assess the transmission of volatility from the US and European stock markets to the UK. Findings - The findings suggest that the UK equity market is more integrated with Europe, in terms of both aggregate stock markets and sectors. Correlations are higher during bear markets and tend to fall during periods of recovery. The sectoral analysis also provides interesting insights into the dynamics of volatility transmission across sectors. Research limitations/implications - The results suggest that the search for a better understanding of the dynamics of correlations between markets and sectors must continue. Practical implications - The investigation raises interesting questions for investors and regulators, as well as theoretical finance. For example, the finding that correlations increase in bear markets suggests that hedging strategies need to be revisited. The existence of sectoral idiosyncratic volatility offers further evidence that arbitrage may at times become more risky and thus limited. Originality/value - The findings from analysing both market-wide and sectoral integration raises the overarching question of whether studies of market integration and portfolio diversification, as well as the authorities overseeing financial stability, should be focusing on sectoral rather than market-wide analysis.

How Value–Glamour Investors Use Financial Information: UK Evidence of Investor’s Confirmation Bias

This paper investigates how investors in value and glamour stocks use financial information. The empirical evidence presented is in line with a model of investors’ asymmetric reaction to good and bad news due to confirmation bias. Pessimistic value investors typically under-react to good financial information, while they process bad information rationally or over-confidently. On the contrary, glamour investors are often too optimistic to timely update prices following bad financial information, while they are likely to fairly price or even over-react when receiving good information.

Positive feedback trading: evidence from futures markets

Shiller (1990) hypothesises that the positive feedback mechanism in financial markets may exhibit longer memory in the sense that feedback may operate over long time intervals. This paper tests the Shiller hypothesis using data from major index futures markets. The analysis is based on a modified dynamic capital asset pricing model that assumes two types of investors: 1) expected utility maximisers; 2) positive feedback traders who sell during market declines and buy during market advances. According to the model, the interaction of the two groups induces negative time varying autocorrelation. There is some evidence of time-varying negative autocorrelation, consistent with the notion that some participants engage in positive feedback trading. Moreover, the feedback mechanism exhibits persistence in support of Shillers (1990) hypothesis.

Regulation and systematic risk: the case of the water industry in England and Wales

This article examines whether regulatory announcements relating to competition, pricing policy and the quality of service in the water industry in England and Wales have an impact on the industrys systematic risk. The results indicate that, although the long-run overall effect of regulation on systematic risk appears to be negligible, competition and quality announcements can have a significant impact upon the industrys systematic risk. Further analysis of individual announcements and companies suggests that price announcements also significantly affect individual companies’ systematic risk, although not in a uniform manner. This indicates that regulators need to be aware that, while some of their policy decisions tend to affect the industry as a whole, others have a diverse impact on individual companies.

Modeling International Price Relationships and Interdependencies between EU Stock Index and Stock Index Futures Markets: A Multivariate Analysis

Over the past fifteen years, financial markets have become increasingly global. The gradual dismantling of regulatory barriers and the introduction of more advanced technology, particularly in data processing and telecommunications, have called for new market structures and practices. Asset and liability management has increasingly become a globally integrated function and the issuance of international securities is often used as a substitute for more traditional funding channels. These developments are to be welcomed in so far as the increased level of competition is expected to lead to a more efficient allocation of capital, both nationally and internationally, lower-cost financial services and new means of hedging risk. However, they also present a new regulatory challenge in securing financial stability. It was the 1987 world-wide stock market crash in particular which highlighted the inadequacies of a regulatory framework still largely based on old institutional divisions and national jurisdictions. In the globalized security markets, the main challenge for both investors and policy makers is to take advantage of and promote efficiency enhancing aspects of market interaction, while containing and controlling the undesirable destabilising effects.

Overvaluation and earnings management: does the degree of overvaluation matters?

We examine whether the choice of earnings management strategies employed by managers of overvalued firms depends on the degree of market overvaluation. By distinguishing between substantially overvalued (SOV) and relatively overvalued (ROV) firms, we find that SOV firms significantly inflate earnings using both accruals-based and real earnings management. In contrast, managers of ROV firms do not engage in accruals-based earnings management and their firms’ accounts tend to report higher discretionary expenses. The reported higher discretionary expenses of ROV firms are comparable to the discretionary expenses of firms in the expanding stage of their business life cycle, a pattern consistent with ROV firms increasing discretionary expenses to finance growth and hence justify the high market valuation. Overall, we show that the existing evidence on income-increasing earnings management by overvalued firms is mainly driven by the pressure to sustain the high market valuation of firms that are substantially overvalued.