Latha Ramchand

Volatility and Cross Correlation Across Major Stock Markets

Several papers have documented the fact that correlations across major stock markets are higher when markets are more volatile - this is done by comparing unconditional correlations over sub-periods or by using conditional correlations that are time varying. In this paper we examine the relation between correlation and variance in a conditional time and state varying framework. We use a switching ARCH (SWARCH) technique that does two things. One, it enables us to model variance as state varying. Two, a bivariate SWARCH model allows us to go from conditional variance to state varying covariances and correlations and hence test for differences in correlations across variance regimes. We find that the correlations between the U.S. and other world markets are on average 2 to 3.5 times higher when the U.S. market is in a high variance state as compared to a low variance regime. We also find that, compared to a GARCH framework, the portfolio choices resulting from our SWARCH model lead to higher Sharpe ratios.

The Impact of Global Equity Offerings

This article examines the impact of U.S. firms issuing equity in multiple markets. We compare the stock price reactions to announcements of global equity offers to a control group of issues offered exclusively in the domestic U.S. market. All else equal, the adverse price reaction that typically accompanies equity issuance is reduced by 0.8 percent when some shares are sold abroad. The overall evidence suggests global offers are effective in expanding demand and reducing the price pressure effects associated with share issuance. The beneits of global offers appear to be associated with an increase in the number of foreign shareholders. Copyright The American Finance Association 2000.

Variances and covariances of international stock returns: the international capital asset pricing model revisited

Abstract In this paper we examine a conditional version of the international capital asset pricing model allowing for a time and state varying factor of proportionality or beta. Betas are allowed to change with an unobserved state variable. Return variances differ across the different states so that betas differ on account of differences in variance regimes of the return series. This method allows us to accommodate a non-linear relation between returns and variances. For six markets, we find that the world beta is a non-linear function of domestic volatility. In the Pacific and North American markets we find strong evidence for a time and state varying beta coefficient. We find that for the European markets, with the exception of Switzerland, the world beta is not related to the state of the domestic markets volatility.

Changes in systematic risk following global equity issuance

Abstract This paper examines changes in systematic risk following global equity issues by US firms. Models of market segmentation show that if international capital markets are not fully integrated and demand curves for securities are downward sloping, firms issue equity at higher prices by issuing in multiple markets compared to issuance on a single domestic market. This would imply a reduction in the firm’s cost of capital and an increase in firm value. Using a sample of global equity offers during 1986–1993, we find that US firms that issue equity abroad experience a decline in systematic risk subsequent to issuance. After controlling for size, volume, and leverage effects, we find that this decline in systematic risk is larger in magnitude for global compared to a control sample of domestic equity issues. The larger the proportion of the offer sold abroad and the larger the increase in trading volume, the bigger the decline in systematic risk. Using a two-factor global risk model we find that while firms issuing equity abroad experience a decline in the domestic component of systematic risk, the foreign component increases. Overall, however, the net effect is a decline in the cost of capital.

Asset pricing in open economies with incomplete markets: implications for foreign currency returns

Abstract This paper extends the incomplete markets model in Constantinides and Duffie (1991. Asset Pricing with Heterogenous Consumers: Good News and Bad News. Manuscript, University of Chicago) to a two country, two goods framework adding another dimension to heterogeneity, viz. cross-country heterogeneity. The paper combines the heterogenous agent economy specified in Constantinides and Duffie with Cobb Douglas preferences as in Cole and Obstfeld (1991. Commodity trade and international risk sharing: how much do financial markets matter? Journal of Monetary Economics). The combination of iso-elastic preferences with an income process that incorporates permanent shocks that are heteroscedastic, results in an equilibrium where agents do not trade both within and across countries. The results on asset prices are similar to the one-country one-good model as in Constantinides and Duffie (1991). Despite heterogeneity, asset prices depend on aggregate endowments. Prices differ from those in the representative agent case on account of differences in the effective risk aversion and time preference rates. Effective risk aversion could be higher and the effective time preference lower compared to the complete markets case. The results on portfolio choice are similar to Cole and Obstfeld (1991) in that agents do not trade assets across countries.

Country level corruption and frequency of issue in the U.S. market

This paper examines if country level corruption affects the size of a country’s stock market and its ability to raise equity capital. Using Transparency International’s ranking of countries based on corruption levels, we relate the corruption index to total market capitalization for a sample of 104 countries and also examine the number and volume of new equity issues in each country across time. Additionally, we examine if corruption affects the frequency of foreign firms’ raising capital in the U.S. We find that the corruption index is not highly correlated to either the number of issues or the total volume of issue. The correlation between the average volume of issue and the TI index suggests that there is no clear cut relation between the corruption index and the likelihood of the firm raising capital abroad.

Private or Public Debt? Effect of Crisis on Financial Intermediation

How did the crisis impact financial intermediation? We address this question by studying a unique market segment, viz. foreign private debt issued in the U.S., which grew in size despite the financial crisis. Specifically, foreign private (or Rule 144A) debt issued in the U.S. increased more than five-fold as between pre-crisis (1999-06) and crisis (2007-09) periods compared to public (or Yankee) debt. At the same time, domestic private (144A) debt issuances by U.S. firms remained relatively flat. Using an exhaustive sample of foreign bond issuances in the U.S. from over 65 countries between 1990 and 2013, we examine the effects of the financial crisis on three key corporate decisions viz., debt choice, pricing, and market timing comparing public (Yankee) and private (Rule 144A) debt issues for all foreign firms. We find that Qualified Institutional Buyers (QIBs), the only investors in unregistered 144A bonds, were preferentially funding foreign firms in the 144A market and at better spreads, despite the firms’ high idiosyncratic risks and leverage, and excessive underlying local market volatility. However, we see no such preference in 144A lending to domestic U.S. borrowers. Overall, our findings are consistent with the flight of intermediation in that while many good quality foreign firms began issuing in U.S. due to local capital constraints, QIBs were able to better allocate their scarce capital in favor of quality private debt borrowers.

Information Processing in the Secondary Foreign Rule 144A Debt Market

We study secondary market trades of debt issues by foreign firms in the U.S. under SEC Rule 144A, a unique market where the counterparties are qualified institutional buyers (QIBs). We find that even though the secondary yield spreads of foreign 144A debt issues are larger than comparable public debt issues by foreign and domestic firms in the U.S., the incremental impact of common risks – namely, credit, illiquidity, governance, and familiarity risks – on spreads are lower for foreign 144A issues compared to various control samples. Our finding is consistent with the notion that institutional participants, namely QIBs, play a specialized role in mitigating risk exposures in the foreign 144A secondary market.