Paolo Pasquariello

On the Volatility and Comovement of U.S. Financial Markets Around Macroeconomic News Announcements

The objective of this paper is to provide a deeper insight into the links between financial markets and the real economy. To that end, we study the short-term anticipation and response of U.S. stock, Treasury, and corporate bond markets to the first release of surprise U.S. macroeconomic information. Specifically, we focus on the impact of these announcements not only on the level, but also on the volatility and comovement of those assets’ returns. We do so by estimating several extensions of the parsimonious multivariate GARCH-DCC model of Engle (2002) for the excess holding-period returns on seven portfolios of these asset classes. We find that both the process of price formation in each of those financial markets and their interaction appear to be driven by fundamentals. Yet our analysis reveals a statistically and economically significant dichotomy between the reaction of the stock and bond markets to the arrival of unexpected fundamental information. We also show that the conditional mean, volatility, and comovement among stock, Treasury, and corporate bond returns react asymmetrically to the information content of these surprise announcements. Overall, the above results shed new light on the mechanisms by which new information is incorporated into prices within and across U.S. financial markets.

Regime Shifts in Asian Equity and Real Estate Markets

This paper applies a new statistical technology for identifying regime shifts to analyze recent data on real estate and equity markets in eight developing Far Eastern countries in the 1992-1998 time period. We find that regime shifts in volatility occur in the summer of 1997; however, most of the regime shifts in returns occur in the spring of 1998. While the clustering of regime breaks does not seem to follow any obvious pattern, the countrys exposure to trade and firm leverage are important. An analysis of Granger causality suggests that, in most cases, equity returns cause real estate returns but the converse is not true. We also find two-way causality in volatility, suggesting that a common factor drives volatility in these markets. Finally, we provide evidence that the regime shifts generally imply higher relative risk for real estate securities after the estimated breaks. Copyright 2002 by the American Real Estate and Urban Economics Association.

An Examination of the Asian Crisis: Regime Shifts in Currency and Equity Markets

Using a nonparametric technique for the identification of regime shifts, we find breaks in the structural relations between currency and equity returns and return volatility in Indonesia, Malaysia, the Philippines, South Korea, Taiwan, and Thailand during the recent Asian crisis. Volatility breaks occurred in late 1994 and 1997, while return breaks were concentrated in early 1998. After the estimated breaks, many Asian equity markets became more responsive to the volatility of the corresponding domestic exchange rate. We find that information spillover and portfolio rebalancing, rather than common information shocks, represented major channels for the transmission of breaks across countries.

Financial Market Dislocations

Dislocations occur when financial markets, operating under stressful conditions, experience large, widespread asset mispricings. This study documents systematic dislocations in world capital markets and the importance of their fluctuations for expected asset returns. Our novel, model-free measure of these dislocations is a monthly average of hundreds of individual abnormal absolute violations of three textbook arbitrage parities in stock, foreign exchange, and money markets. We find that investors demand statistically and economically significant risk premiums to hold financial assets performing poorly during market dislocations, that is, when both frictions to the trading activity of speculators and arbitrageurs and their marginal utility of wealth are likely to be high.

Prospect Theory and Market Quality

We study equilibrium trading strategies and market quality in an economy in which speculators display preferences consistent with Prospect Theory (Kahneman and Tversky, [39]; Tversky and Kahneman, [63]), i.e., loss aversion and mild risk seeking in losses. Loss aversion (risk seeking in losses) induces speculators to trade less (more), and less cautiously (more aggressively), with their private information – but also makes them less (more) inclined to purchase private information when it is costly – in order to mitigate (enhance) their perceived risk of a trading loss. We demonstrate that these forces have novel, nontrivial, state-dependent effects on equilibrium market liquidity, price volatility, trading volume, market efficiency, and information production.

Informative Trading or Just Noise? An Analysis of Currency Returns, Market Liquidity, and Transaction Costs in Proximity of Central Bank Interventions

We study the impact of Central Bank intervention on the process of price formation in currency markets. We use a unique dataset of tick-by-tick indicative quotes posted by dealers on Reuters terminals and of intraday sterilized spot interventions and customer transactions executed on behalf of the Swiss National Bank (SNB) on the Swiss Franc/U.S. Dollar exchange rate (CHFUSD) between 1986 and 1998. We find that SNB interventions (but not ex post uninformative customer transactions), although being smaller than typical forex trades, had significant and persistent (albeit asymmetric, depending on their sign) effects on daily currency returns, especially when (relatively) large in magnitude, expected by the market, or inconsistent with existing momentum. The market did not anticipate the occurrence of incoming interventions, unless if chasing the trend. The SNB was much less successful in smoothing fluctuations of the currency, for daily CHFUSD volatility always surged in proximity of interventions, as did average absolute and proportional spreads. Decomposition of estimated absolute spread shocks also reveals that SNB actions induced misinformation among market participants, impacted current market liquidity, increased competition among dealers, and reduced trading immediacy. In many cases, these changes translated into higher transaction costs borne by the population of investors.

Strategic Cross-Trading in the U.S. Stock Market

We model and test for the role of heterogeneously informed, strategic multi-asset speculation for cross-price impact—the impact of trades in one asset on the prices of other (even unrelated) assets—in the U.S. stock market. Our investigation of the trading activity in New York Stock Exchange (NYSE) and National Association of Securities Dealers Automated Quotation System (NASDAQ) stocks between 1993 and 2004 reveals that, consistent with our model, (1) daily order imbalance in one industry or random stock has a significant, persistent, and robust impact on daily returns of other (even unrelated) industries or random stocks; (2) cross-price impact is often negative; and (3) both direct (i.e., an asset’s own) and absolute (i.e., unsigned) cross-price impact are smaller when speculators are more numerous, greater when market-wide dispersion of beliefs is higher, and greater among stocks dealt by the same specialist.

Uncertainty of trading rules in currency markets: an application of non-parametric bootstrapping

An apparatus and method for simultaneously anodizing the heads of several aluminum pistons includes a plating tank having an array of apertures extending through one of its side walls, one aperture for each piston; and means for securing the head of each piston in its respective aperture. A seal disposed in each aperture ensures that the aperture is sealed upon the securing of the piston therein, with only the pistons head being placed in fluid communication with the interior of the plating tank. An acid electrolyte is directed into the plating tank through electrically-conductive sparging nozzles positioned therein opposite the heads of the pistons, thereby forming an electrolytic cell with the pistons as anodes and the sparging nozzles as cathodes. A power supply simultaneously applies a current to the cell, i.e., across the electrolyte via the pistons and sparger nozzles, to effect electrolytic coating of each pistons head. After the desired coating is achieved, the current is removed and the electrolyte drained from the tank. Rinse water is then directed into the tank through the same sparging nozzles to rinse any remaining electrolyte from the pistons. After the rinse water is drained, hot water is directed into the tank through the sparging nozzles to seal the coating. After a final draining of the tank, the coated pistons are removed from the apertures.

Speculation with Information Disclosure

Sophisticated financial market participants frequently choose to disclose private information to the public — a phenomenon inconsistent with most theories of speculative trading. In this paper, we propose and test a model to bridge this gap. We show that when a speculator cares about both the short-term value of her portfolio and her long-term profit, information disclosure is incentive compatible: Disclosure in the form of a mixture of fundamental information and the speculator’s position induces competitive dealership to revise prices in the direction of the speculator’s position. Using mutual fund disclosure through newspaper articles, we find that when fund managers have stronger estimated ex ante short-term incentives, the frequency of strategic disclosures about stocks in their portfolios increases and those stocks’ liquidity improves, consistent with our model.

The New Asia: Regime Shifts in Currency and Equity Markets

This paper analyzes the structural relationship between currency and equity markets in ten Far Eastern countries during the recent Asian crisis. This analysis is done separately for returns and for volatilities. Using a new statistical technology for identifying regime shifts, we are able to demonstrate how information shocks in these markets moved from country to country in the 1992-1998 time period. We also create confidence intervals for when the most significant regime shifts occurred in each country. We find that volatility breaks occur prior to return breaks; more specifically, shifts in the volatility structure occurred in fall 1997 for most countries in our sample, while most shifts in the return structure occurred in mid 1998. The sequential nature of the observed regime shifts is consistent with the notion that return and volatility linkages among Asian markets were created by information spillover effects. Our study also shows that the negative relationship between volatility and returns found by French, Schwert and Stambaugh (1987) for the U.S. market holds for Asian markets. Furthermore, our results indicate that the information shocks in this crisis are related more to equity market movements, in particular, capital flight, than to foreign exchange shocks. An analysis of flow of funds data provides further evidence that information spillover or herding effects generate the observed return and volatility relationships among these countries.