Stuart Hyde

The Response of Industry Stock Returns to Market, Exchange Rate and Interest Rate Risks

This study investigates the sensitivity of stock returns at the industry level to market, exchange rate and interest rate shocks in the four major European economies: France, Germany, Italy and the UK. In addition to exposure to the market, significant levels of exposure to both exchange rate risk, in the four countries, and interest rate risk, in France and Germany, are identified. Further, responses to sources of risk are decomposed into components attributable to news about future dividends, real interest rates and excess returns. All three sources of risk contain significant information about future cash flows and excess returns.

Correlation dynamics between Asia-Pacific, EU and US stock returns

This paper investigates the correlation dynamics in the equity markets of 13 Asia-Pacific countries, Europe and the US using the asymmetric dynamic conditional correlation GARCH model (AG-DCC-GARCH) introduced by Cappiello, Engle and Sheppard (2006). We find significant variation in correlation between markets through time. Stocks exhibit asymmetries in conditional correlations in addition to conditional volatility. Yet asymmetry is less apparent in less integrated markets. The Asian crisis acts as a structural break, with correlations increasing markedly between crisis countries during this period though the bear market in the early 2000s is a more significant event for correlations with developed markets. Our findings also provide further evidence consistent with increasing global market integration. The documented asymmetries and correlation dynamics have important implications for international portfolio diversification and asset allocation.

Regime Change and the Role of International Markets on the Stock Returns of Small Open Economies

We examine the influence of US, UK and German macroeconomic and financial variables on the stock returns of two relatively small, open European economies, Ireland and Denmark. Within a nonlinear framework, we allow for time variation via regime switching using a smooth transition regression (STR) model. We find that US (global) and UK and German (regional) stock returns are significant determinants of returns in both markets. Further, global information represented by oil and US asset price movements drive changes between states in each market. Significantly, the role of country-specific domestic variables is typically confined to a single state while global and regional variables pervade all states.

Chapter 3 Correlation dynamics between Asia-Pacific, EU and US stock returns

This chapter investigates the correlation dynamics in the equity markets of 13 Asia-Pacific countries, Europe and the US using the asymmetric dynamic conditional correlation GARCH model (AG-DCC-GARCH) introduced by Cappiello, Engle, and Sheppard (2006). We find significant variation in correlation between markets through time. Stocks exhibit asymmetries in conditional correlations in addition to conditional volatility. Yet asymmetry is less apparent in less integrated markets. The Asian crisis acts as a structural break, with correlations increasing markedly between crisis countries during this period though the bear market in the early 2000s is a more significant event for correlations with developed markets. Our findings also provide further evidence consistent with increasing global market integration. The documented asymmetries and correlation dynamics have important implications for international portfolio diversification and asset allocation.

Excess volatility and efficiency in French and German stock markets

Abstract In this paper, we analyse whether the French and German stock markets can be classified to be efficient or whether they exhibit excess volatility. We assess efficiency in each market by employing the VAR methodology of Campbell and Shiller (Campbell, J.Y., Shiller, R.J., 1988b. The dividend–price ratio and expectations of future dividends and discount factors. Rev. Financ. Stud. 1, 195–228) and adopting two alternative assumptions regarding equilibrium expected returns. The first model assumes that equilibrium expected excess returns are constant, while the second model assumes that equilibrium returns depend upon a time varying risk premium which varies with the conditional expectation of the return variance (i.e. the CAPM). We find that the model which assumes constant excess returns is clearly rejected for both France and Germany. However, the volatility (CAPM) model provides some evidence for efficiency.

Does the Macroeconomy Predict UK Asset Returns in a Nonlinear Fashion? Comprehensive Out‐Of‐Sample Evidence

We perform a comprehensive examination of the recursive, comparative predictive performance of linear and nonlinear models for UK stock and bond returns. We estimate Markov switching, threshold autoregressive (TAR) and smooth transition autoregressive (STR) regime switching models and a range of linear specifications including models with GARCH type specifications. Results demonstrate UK asset returns require nonlinear dynamics to be modelled with strong evidence in favour of Markov switching frameworks. Our results appear robust to the choice of sample period, changes in loss functions and to the methodology employed to test for equal predictive accuracy. The key findings extend to a similar sample of US data.

What Tames the Celtic Tiger? Portfolio Implications from a Multivariate Markov Switching Model

We use multivariate regime switching vector autoregressive models to characterize the time-varying linkages among the Irish stock market, one of the top world performers of the 1990s, and the US and UK stock markets. We find that two regimes, characterized as bear and bull states, are required to characterize the dynamics of excess equity returns both at the univariate and multivariate level. This implies that the regimes driving the small open economy stock market are largely synchronous with those typical of the major markets. However, despite the existence of a persistent bull state in which the correlations among Irish and UK and US excess returns are low, we find that state comovements involving the three markets are so relevant to reduce the optimal mean–variance weight carried by ISEQ stocks to at most one-quarter of the overall equity portfolio. We compute time-varying Sharpe ratios and recursive mean–variance portfolio weights and document that a regime switching framework produces out-of-sample portfolio performance that outperforms simpler models that ignore regimes. These results appear robust to endogenizing the effects of dynamics in spot exchange rates on excess stock returns.

Don't Break the Habit: Structural Stability Tests of Consumption Asset Pricing Models in the UK

This paper investigates the structural stability of four alternative consumption based asset pricing models, the traditional power utility consumption based capital asset pricing model (C-CAPM), the recursive preferences model proposed by Epstein and Zin (1989, 1991), and two habit formation specifications, the form proposed by Abel (1990) and the model of Campbell and Cochrane (1999), using the tests of Hall and Sen (1999). The ability of the models to price stocks and stocks and a short-term interest rate (i.e., the equity premium) is assessed. Evidence is found supportive of both the habit formation specifications and the traditional C-CAPM. The preferred specification based on parameter estimates and structural stability is that of Campbell and Cochrane.

Simple VARs cannot approximate Markov switching asset allocation decisions: An out-of-sample assessment

In a typical strategic asset allocation problem, the out-of-sample certainty equivalent returns for a long-horizon investor with constant relative risk aversion computed from a range of vector autoregressions (VARs) are compared with those from nonlinear models that account for bull and bear regimes. In a horse race in which models are not considered in their individuality but instead as an overall class, it is found that a power utility investor with a relative risk aversion of 5 and a 5 year horizon is ready to pay as much as 8.1% in real terms to be allowed to select models from the Markov switching (MS) class, while analogous calculation for the whole class of expanding window VARs leads to a disappointing 0.3% per annum. Most (if not all) VARs cannot produce portfolio rules, hedging demands, or out-of-sample performances that approximate those obtained from equally simple nonlinear frameworks.

Duration, trading volume and the price impact of trades in an emerging futures market

This paper examines the price impact of trading intensity on the MexDer TIIE28 interest rate futures contract, one of the worlds most actively traded contracts. A novel volume-augmented duration model of price discovery decomposes trading intensity into liquidity and information components. Duration between transactions exerts a positive influence on price changes, while increases in order flow and trade volume exert positive and negative influences, respectively. The liquidity component dominates the information measure, suggesting that liquidity considerations dictate trade timing. These findings are rationalized with reference to MexDers organizational structure, specifically the affirmative obligations placed upon marketmakers to trade a minimum volume.