Riza Demirer

Investor Herds and Regime-Switching: Evidence from Gulf Arab Stock Markets

This paper proposes a dynamic herding approach which takes into account herding under different market regimes, with concentration on the Gulf Arab stock markets – Abu Dhabi, Dubai, Kuwait, Qatar and Saudi Arabia. Our results support the presence of three market regimes (low, high and extreme or crash volatility) in those markets with the transition order ‘low, crash and high volatility’, suggesting that these frontier markets have a different structure than developed markets. The results also yield evidence of herding behavior under the crash regime for all of the markets except Qatar which herds under the high volatility regime. The findings of the cross-GCC herding model also demonstrate herding comovements and not spillovers and are also robust to the cross-GCC volatility shocks. The tests that underline the cross-volatility shocks suggest that the crash regime is a true regime and not a statistical artifact. Policy and portfolio diversification implications are discussed.

Downside risk for short and long hedgers

Abstract This paper assumes that each individual attempts to minimize the downside risk measured by the lower partial moments (LPMs). Optimal hedge ratios and the resultant hedging performance are compared for short versus long hedgers across 10 different markets. It is found that long hedgers tend to be more active in futures trading (particularly in commodity markets) and provide better hedging performance (particularly in currency and stock index markets). An optimistic hedger trades more futures contracts whereas a hedger overly concerned with bad outcomes will trade less.

Subset selection in multiple linear regression: a new mathematical programming approach

A new mathematical programming model is proposed to address the subset selection problem in multiple linear regression where the objective is to select a minimal subset of predictor variables without sacrificing any explanatory power. A parametric solution of this model yields a number of efficient subsets. To obtain this solution, an optimal or one of two heuristic algorithms is repeatedly used. The subsets generated are compared to ones generated by several standard procedures. The results suggest that the new approach finds subsets that compare favorably against the standard procedures in terms of the generally accepted measure: adjusted R^2.

Effect of Global Shocks and Volatility on Herd Behavior in an Emerging Market: Evidence from Borsa Istanbul

In this article, we examine the dynamic relationship between global factors and herd behavior in an emerging market. Utilizing a time-varying transition probability Markov-switching model, we examine the role of global risk factors on investor behavior in Borsa Istanbul, which is dominated largely by foreign investors. Our tests yield three distinct market regimes (low, high, and extreme volatility) and evidence consistent with herd behavior during both the high- and extreme-volatility regimes. U.S. market–related factors are found to dominate regime transitions and thus significantly contribute to herd behavior in all market sectors with the exception of industrials, suggesting that industrials are relatively immune to global shocks. Multivariate synchronization tests further suggest that herding regimes are perfectly synchronized across all market sectors.

Sequential valuation networks for asymmetric decision problems

Abstract This paper deals with representation and solution of asymmetric decision problems. We describe a new representation called sequential valuation networks that is a hybrid of Covaliu and Oliver’s sequential decision diagrams and Shenoy’s valuation networks. The solution algorithm is based on the idea of decomposing a large asymmetric problem into smaller sub-problems and then using the fusion algorithm of valuation networks to solve the sub-problems. Sequential valuation networks inherit many of the strengths of sequential decision diagrams and valuation networks while overcoming many of their shortcomings. We illustrate our technique by representing and solving a modified version of Covaliu and Oliver’s [Manage. Sci. 41(12) (1995) 1860] Reactor problem in complete detail.

Can Advanced Markets Help Diversify Risks in Frontier Stock Markets? Evidence from Gulf Arab Stock Markets

This study examines global diversification benefits from the perspective of local investors in the frontier markets in the Gulf Cooperation Council using two diversification measures: the correlation index and return dispersion. The findings suggest a strong link between market volatility and both diversification measures in all markets, with the exception of Bahrain, indicating that investors in these frontier markets will face significant challenges achieving desired levels of diversification using domestic stocks only. However, I also find that significant amount of market risk in these countries can be eliminated by supplementing domestic portfolios with positions in advanced markets. Finally, I show that risk minimization strategies using foreign traded assets also lead to favorable risk adjusted returns for investors in these markets, stressing the potential benefits of financial liberalization in developing markets.

Sequential Valuation Networks: A New Graphical Technique for Asymmetric Decision Problems

This paper deals with representation and solution of asymmetric decision problems. We describe a new graphical representation called sequential valuation networks, which is a hybrid of Covaliu and Olivers sequential decision diagrams and Shenoys asymmetric valuation networks. Sequential valuation networks inherit many of the strengths of sequential decision diagrams and asymmetric valuation networks while overcoming many of their shortcomings. We illustrate our technique by representing and solving a modified version of Covaliu and Olivers Reactor problem.

Firm-level return dispersion and correlation asymmetry: challenges for portfolio diversification

The main purpose of this article is to study whether firm-level return dispersions might have any significance in explaining asymmetric return correlations observed in equity market returns. Correlation asymmetry, in particular increased return correlations conditional on downside moves, implies that portfolio diversification will not be as successful during bear markets – periods during which portfolio diversification will be most needed. Similarly, low firm-level return dispersion imply that stocks within the portfolio behave the same way, making diversification harder. It is found that asymmetric correlations are associated with asymmetric firm-level return dispersions. The results indicate that portfolio managers need to not only take into account the asymmetry in return correlations but also be aware of how firm-level return dispersions behave during such periods when they need diversification most.

Is there a role for Islamic bonds in global diversification strategies

Purpose - – The purpose of this paper is to examine the international diversification benefits of Islamic bonds (Sukuk) for equity investors in conventional stock markets. The authors compare the diversification benefits of these securities with their conventional alternatives from advanced and emerging markets. Compared to conventional bonds, Sukuk are backed by tangible assets and carry both bond and stock-like features. Furthermore, the Sharia-based limitations limit the risk in these securities as a result of ethical investing rules. The regime-based model provides insight to possible segmentation (or integration) of these securities from global markets during different market states. Design/methodology/approach - – Risk spillover effects across conventional and Islamic stock and bond markets are examined using a Markov regime-switching GARCH model with dynamic conditional correlations (MS-DCC-GARCH). Weekly return series for conventional (advanced and emerging) and Islamic stock and bond indices are examined within a regime-dependent specification that takes into account low, high, and extreme volatility states. The DCC are then used to establish alternative diversified portfolios formed by supplementing conventional and Islamic equities with conventional and Islamic bonds one at a time. Findings - – Asymmetric shocks are observed from conventional stocks and bonds into Islamic bonds (Sukuk). Compared to emerging market bonds, Sukuk are found to display a different pattern in the transmission of global market shocks. The analysis of dynamic correlations suggests a low degree of association between Islamic bonds and global stock markets with episodes of negative correlations observed, particularly during market crisis periods. Portfolio performance analysis suggests that Islamic bonds provide valuable diversification benefits that are not possible to obtain from conventional bonds. Originality/value - – This study provides comprehensive analysis of volatility interactions and dynamic correlations across Islamic and conventional markets within a regime-based framework and provides insight to whether these securities could serve as safe havens or diversifiers for global investors. The findings have significant implications for global diversification strategies, particularly during market crisis periods.

Regional and Global Spillovers and Diversification Opportunities in the GCC-Wide Equity Sectors Across Market Regimes

This paper examines the international diversification benefits of nine bloc-wide equity sectors/subsectors in the oil-rich Gulf Cooperation Council (GCC) countries by comparing alternative spillover models that encompass local, regional and global factors. Both the return and volatility spillover effects are found to display time variations with regime-specific patterns based on low, high and extreme market volatility states. Some GCC-wide equity sectors/subsectors are found to display segmentation from global markets during periods of high and extreme market volatility, and thus can serve as safe havens for international investors during such periods. The in- and out-of-sample portfolio analyses further suggest that supplementing global portfolios with positions in the GCC markets yield significant international diversification benefits, consistently offering much improved risk-adjusted returns across the alternative spillover models.