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Equilibrium moment restrictions on asset returns: normal and crisis periods

Equilibrium moment restrictions on asset returns: normal and crisis periods
Equilibrium moment restrictions on asset returns: normal and crisis periods
Empirically, the covariance between stock returns varies with their volatility. We seek a robust theoretical explanation of this. With minimal assumptions, we model stochastic properties of equilibrium returns which result from the interaction between inter-temporal traders and noisy, price-sensitive short-term traders. The inter-temporal traders can have arbitrary investment rules, preferences and information. In all cases we find a set of restrictions between second moments of equilibrium returns. With two assets there is also a bound on the correlation between asset returns. Estimation with second moments of global stock returns supports our theoretical framework. Higher volatility in at least one market can increase comovement among markets. With globalization, covariances between two stock markets can also affect covariances between two other stock markets. We also find that the changes in trader behavior between normal and crisis periods lead to changes in the moment restrictions between asset returns.
short-term traders, asset returns, equilibrium moment restrictions, correlation bound
1351-847X
1064-1089
Simmons, Peter
1c22ea76-208a-44a3-bea5-4dec5d8ef7e9
Tantisantiwong, Nongnuch
73b57288-a4dc-4456-8d1b-12b8d07dc3b4
Simmons, Peter
1c22ea76-208a-44a3-bea5-4dec5d8ef7e9
Tantisantiwong, Nongnuch
73b57288-a4dc-4456-8d1b-12b8d07dc3b4

Simmons, Peter and Tantisantiwong, Nongnuch (2014) Equilibrium moment restrictions on asset returns: normal and crisis periods. European Journal of Finance, 20 (11), 1064-1089. (doi:10.1080/1351847X.2012.742024).

Record type: Article

Abstract

Empirically, the covariance between stock returns varies with their volatility. We seek a robust theoretical explanation of this. With minimal assumptions, we model stochastic properties of equilibrium returns which result from the interaction between inter-temporal traders and noisy, price-sensitive short-term traders. The inter-temporal traders can have arbitrary investment rules, preferences and information. In all cases we find a set of restrictions between second moments of equilibrium returns. With two assets there is also a bound on the correlation between asset returns. Estimation with second moments of global stock returns supports our theoretical framework. Higher volatility in at least one market can increase comovement among markets. With globalization, covariances between two stock markets can also affect covariances between two other stock markets. We also find that the changes in trader behavior between normal and crisis periods lead to changes in the moment restrictions between asset returns.

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More information

Accepted/In Press date: 16 October 2012
e-pub ahead of print date: 22 January 2013
Published date: 1 November 2014
Keywords: short-term traders, asset returns, equilibrium moment restrictions, correlation bound
Organisations: Centre for Digital, Interactive & Data Driven Marketing, Banking & Finance

Identifiers

Local EPrints ID: 369322
URI: http://eprints.soton.ac.uk/id/eprint/369322
ISSN: 1351-847X
PURE UUID: 4799bb75-23df-4aa4-9a3c-82f0079884eb

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Date deposited: 03 Oct 2014 14:21
Last modified: 14 Mar 2024 18:00

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Contributors

Author: Peter Simmons
Author: Nongnuch Tantisantiwong

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