How current accounts mislead FX markets

October 31, 2015

A common fallacy is that current account deficits measure dependence on external financing. In reality, external balances and cross border financing are only vaguely related. Vulnerability to “stops” in financial flows does not depend on trade and capital flows (“net concept”) but only on the volume and origin of financing (“gross concept”). Currency crises are not about current accounts that need to adjust, but about funding gaps that need to be closed.

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Understanding duration feedback loops

October 17, 2015

When long-term government bond yields are low enough, further declines can ‘feed on themselves’. European insurance companies and pension funds are plausible catalysts. The duration gap between their liabilities and assets typically widens non-linearly when yields are low and compressed further, triggering sizeable duration extension flows.

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Liquidity risk in European bond markets

October 10, 2015

There are signs of liquidity decline and liquidity illusion in euro area government bond markets. Citibank research suggests that liquidity risk is rising due to increased capital requirements for dealers, reduced market maker inventories, enhanced dealer transparency rules, elevated assets under management of bond funds, and the liquidity transformation provided by these funds.

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Commodity trading strategies and convenience yields

October 3, 2015

Convenience yield can be interpreted as a leasing rate for physical commodities. Returns on convenience claims are premia earned by investment strategies for providing this leasing service. An empirical analysis suggests that they depend on risk factors related to other asset classes, however. The inertia in these risk factors seems to help predicting returns on convenience claims.

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Hints for cross-country equity strategies

September 19, 2015

An academic paper looks at cross-country relative-value equity strategies. It concludes that [i] relative conventional factors might create alpha and [ii] relative local country equity index returns are uncorrelated with currency returns (and hence the two could be independent value creators).

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Why decision makers are unprepared for crises

September 13, 2015

An ECB working paper explains formally why senior decision makers are unprepared for crises: they can only process limited quantities of information and rationally pay attention to rare events only if losses from unpreparedness seem more than inversely proportionate to their rarity. The less probable a negative event, the higher the condoned loss. Inattention gets worse when managers bear only limited liability.

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What markets can learn from statistical learning

September 5, 2015

Understanding statistical learning is critical in modern markets, even for non-quants. Statistical learning works with complex datasets to forecast returns or to estimate the impact of specific events. The choice of methods is key: they range from simple regression to complex machine learning. Simplicity can deliver superior returns if it avoids “overfitting” (gearing models excessively to specific past experiences). Success must be measured in “out-of-sample” predictive power, after a model has been selected and estimated.

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How EM bond funds exaggerate market volatility

August 31, 2015

A new BIS paper provides evidence that since 2013 fluctuations in EM fund flows and EM bond prices have reinforced each other. Both redemptions and discretionary sales of fund managers have been pro-cyclical. In liquidity-constrained markets this behavior is prone to transmitting shocks and amplifying crises.

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Liquidity events

August 16, 2015

A recent speech by Fed governor Jerome Powell highlights recurrent episodes of short-term distress and vanishing liquidity in large developed markets. Increases in trading speed, market concentration, and regulatory costs of market making all may be contributing to these liquidity events.

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A primer on benchmark index effects

August 15, 2015

An HKMIR paper explains benchmark index changes and shows their significant effects on mutual fund flows and international capital flows. Importantly, there is evidence for benchmark changes leading to an outperformance of upgraded assets, both at the time of announcement and the time of actual index adjustment.

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asset management Asset Purchase Program banks bond returns bond yields bubbles capital regulation carry China collateral commodities credit returns default ECB economic data EM equity returns euro area crisis Fed financial crisis FX FX interventions FX returns government debt government deficits herding inflation information insurances Japan leverage liquidity machine learning market turmoil price factors regulation risk management shadow banking statistical methods term structure trend following variance risk premium VIX volatility ZLB
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