Owain ap Gwilym

Extreme price clustering in the London equity index futures and options markets

Price clustering and optimal tick sizes have recently been topics of substantial public policy interest, and this paper presents evidence which is relevant to both debates. Around 98% of quoted and traded prices for LIFFE stock index derivatives are found to occur at even ticks. We report that clustering increases with volatility and transaction frequency, and decreases with trade size, and find that the proportion of odd ticks is significantly lower near the market open and higher near the close. Further, an inverse relationship is reported between bid–ask spreads and the number of odd ticks, and spreads cluster at even-tick values. This evidence of extreme price clustering is the first to be presented for financial derivatives. The results support both the price resolution and the negotiation hypotheses of price clustering.

Price clustering and bid-ask spreads in international bond futures

Abstract We examine price clustering in government bond futures contracts traded at the London International Financial Futures and Options Exchange (LIFFE) and its impact on bid-ask spreads. This open outcry environment provides a rich dataset comprising all quotes and trades, in contrast to data from markets such as the Chicago Mercantile Exchange (CME), which only includes price-change transactions. The German and UK bond futures have low levels of price clustering, and bid-ask spreads are concentrated at the minimum tick size. In contrast, the Italian and Japanese contracts reveal considerably more clustering, and this coincides with wider spreads. We also present evidence on the relationship between the degree of price clustering and trade size.

Dividend Stability, Dividend Yield and Stock Returns: UK Evidence

This paper establishes an empirical role for two measures of dividend stability (as a proxy for dividend policy) in explaining UK stock returns. There is little systematic empirical evidence concerning the relation between dividend stability, dividend yield and stock returns despite the fact that a variety of theoretical models point to dividend policy as an important stock attribute. Here we construct two definitions of dividend stability, one of which involves dividend cuts, and use a sample of all listed UK firms from 1975 to 1997 to explore the relationship between stock returns and a variety of characteristics, including dividend stability. We find an inverse correlation between the stability of past dividend policy and systematic risk. Both stability measures have explanatory power over returns, but this is concentrated in January. Copyright Blackwell Publishers Ltd 2000.

Credit default swaps: Theory and Empirical Evidence.

Structural and reduced-form models are the primary vehicles for pricing credit default swaps (CDS). This evaluation of the emerging empirical literature on CDS analyzes the evidence on the impact of recovery forms on pricing models, the relationship between CDS premiums and credit spreads on the same reference entity, the determinants of CDS premiums, and interaction between the CDS market and other markets.

The lead-lag relationship between the FTSE100 stock index and its derivative contracts

This paper examines the lead/lag relationships between the FTSE100 stock market index and its related futures and options contracts, and also the interrelation between the derivatives markets. Both the index futures and index options contracts are found to lead the cash index as predicted. However, the call option market appears to marginally lead both the index futures and the put option market. In the only previous paper to examine the inter-market relationships between a stock index and related futures and options contracts, Fleming et al (Journal of Futures Markets, 16, 353-387, 1996) maintain that relative trading costs determine which market leads. As the trading costs of calls and puts are similar, other factors must be driving the relationships observed in this paper. We hypothesize that informed traders with bullish expectations wishing to gain leverage from the options market will buy calls or, with greater risk, sell puts. As market sentiment was bullish for most of the sample period examined, this could explain the call market leads reported.

International Evidence on the Payout Ratio, Earnings, Dividends, and Returns

Recent evidence for the U.S. market has shown that, contrary to popular wisdom, the greater the proportion of earnings paid out as dividends, the greater the subsequent real earnings growth. This study extends previous work by examining whether a similar relationship exists in 11 international markets and by considering the role the payout ratio plays in explaining future real dividend growth and returns. Higher payout ratios do indeed lead to higher real earnings growth—but not to higher real dividend growth. This information has limited use, however, for predicting future returns. Although the payout ratio has long been of importance to corporate finance researchers, it has been relatively neglected in the asset-pricing and prediction literature, despite market fascination with investment strategies based on dividends and earnings (e.g., the “Dow 10”). Recent research has established the somewhat surprising result that higher aggregate payout ratios for the United States are associated with higher future earnings growth. This finding offers support for theories that view dividends as signals for earnings expectations. Our article contributes to the literature by investigating whether similar conclusions can be drawn about 11 major international markets and by extending the analysis to consider the relationship between payout ratio and returns, which we believe to be important because returns are the ultimate focus of portfolio managers and investment strategists. For each country, we used monthly values of the dividend yield, earnings yield, a retail price index or consumer price index (as appropriate), and the stock market index level. We also constructed a return series for each countrys index. We investigated the explanatory power of the following variables: payout ratio, dividend yield, earnings yield, lagged dividend growth, and lagged earnings growth. We examined three time periods (determined by data availability) and for the lagged variables used lags of 10 years, 5 years, and 1 year—depending on the length of the sample period. We found that, despite the different institutional, tax, and legal environments of the 11 countries, substantial reinvestment of retained earnings did not increase future real earnings growth, although it did produce faster real dividend growth. Investing in the countries with the higher payout ratios also resulted in higher earnings growth. Unfortunately, these findings did not translate to return predictability in a persuasive fashion: The results varied by country and time period. The notable exception was the U.S. market, where we found the payout ratio to be a significant variable in explaining subsequent 5-year and 10-year returns. Currently, the components of the S&P 500 are paying out around one-third of their earnings as dividends, well below the post-World War II average of 50-60 percent. Therefore, our findings suggest that the outlook for earnings growth in the next few years is ominous.

The Determinants of CDS Bid-Ask Spreads

Recently, the issue of liquidity has generated considerable attention in financial research. In this article, Meng and ap Gwilym analyze the determinants of liquidity in the market for credit default swaps, as measured by the width of their bid-ask spreads. Many of the “usual suspects” are found to have explanatory power: Spreads were wider for higher CDS spread volatility, for lower issuer credit rating, and for sovereign vs. corporate issuers in speculative grades; spreads were lower for 5-year contracts than for nonstandard maturities, for larger transaction size, and for the years 2004 and 2005. One significant finding in the article is that a demand/supply imbalance between protection buyers and protection sellers significantly widens spreads.

Volatility Transmission Among the CDS, Equity, and Bond Markets

This article investigates volatility transmission among the credit default swap (CDS), equity, and bond markets, using a multivariate GARCH model. The authors hypothesise that volatility in the bond and equity markets can originate from the CDS market where there is potential insider trading and increased trading activity due to private credit information. However, the authors find little evidence to support this. There is evidence for an alternative view that as investors search for yield across different asset classes the links among the CDS, bond, and equity markets strengthen. Volatility in any of the three markets is commonly transmitted to the other two markets.

Dividend yield investment strategies, the payout ratio and zero dividend stocks

This study considers the application of both high-and zero-dividend strategies to the U.K. market. Following recent academic studies we conjecture that the payout ratio may provide a useful additional filter for portfolio construction and that zero-dividend stocks may also offer higher returns. These strategies do indeed outperform both the high-yield and index returns on an absolute basis but not when adjusted for risk and transaction costs.

An empirical comparison of quoted and implied bid–ask spreads on futures contracts

This paper investigates the performance of a range of alternative measures of quoted and implied bid–ask spreads on futures contracts, using a complete record of all quotes and trades. Accurate calibration of bid–ask spreads is important for many applications, including tests of market efficiency and assessment of market microstructure models. The results show that the transactions based spread measures are biased estimates of quoted and effective spreads, which illustrates the need for considered implementation of such measures. Similar intraday behaviour is shown by the different measures, with wide spreads at the open and narrow spreads at the close under a competing market maker environment.