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Category Archives: G15

Wrangling the Herd: A Cross-Cultural and Cross-Industry Approach to Herding Market Behavior

By Tyler Fenton and Jarred Kotzin

The traditional efficient market hypothesis serves as the foundation of modern economic theory, governing the investigation of financial markets. While this premise assumes all investors are rational and all information is immediately incorporated into markets, this paper explores herding behavior – a central tenet of behavioral finance that explains the apparent inefficiencies of financial markets. Utilizing return data from the past 10 years from eight exchanges around the world, segmented into 10 industry classes as well as a broad market index, we compare levels of herd behavior using return dispersion proxies. We find significant evidence of herding in nearly all exchanges and all industries included in the study and the degree of this herd behavior varies across industries in different countries. Overall, we find support for the behavioral finance principle of herding and conclude that certain cultural or non cultural factors affect this activity differently in various countries and industries.

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Advisors: Professor Connel Fullenkamp | JEL Codes: G4, G14, G15

Word-of-Mouth Effects in the Holdings and Trading Activities among Canadian Mutual Fund Managers

By Chang Liu

The study tests the word-of-mouth effects among mutual fund managers in Canada with methodology based on a previous study (Hong et al., 2005), with multiple modifications to it such as the method to locate the mutual fund managers. The results confirm the original findings yet with unexpected outcomes. This study demonstrates smaller word-of-mouth effects compared to the original study and reverse word-of-mouth effects in the largest financial city of Canada. The possible interpretations are further discussed in detail, among which a dynamic model of word-of-mouths effects and product differentiation is introduced. The study also discusses the market structure’s possible implications on such dynamic models.

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Advisor: Jia Li | JEL Codes: G02, G15, G20, G21 | Tagged: Word-of-Mouth, Product Differentiation, Herding Behavior

Market Dynamics and the Forward Premium Anomoly: A Model of Interacting Agents

By Phillip Hogan

This paper presents a stochastic model of exchange rates, which is used to explain the forward premium anomaly. In the model, agents switch between four trading strategies, and these changes drive the evolution of the exchange rate. This framework is meant to more realistically represent the important market dynamics of exchange rates, as we suspect these to be the cause of the forward premium anomaly. Our simulations of the model indicate two conclusions: (i) many of the statistical regularities observed in currency markets, including the forward premium anomaly, can be thought of as macro-level scaling laws emerging from micro-level interactions of heterogeneous agents, and (ii) the dynamics of estimates of the beta coefficient in tests of UIP are driven by perceived relationships between changes in interest rates and agents’ aggregate views on the value of the exchange rate, which we call the fundamental value. Section I presents an introduction to the topic and section II reviews the relevant literature. Section III provides the theoretical basis of the forward premium anomaly and our model, then the mathematical definition of the model. Section IV presents the results of a typical simulation which section V compares to relevant stylized facts of the currency markets. Sections VI and VII present our results and a conclusion of what we have drawn from the model.

Honors Thesis

Advisor: Craig Burnside, Michelle Connolly | JEL Codes: G1, G13, G15 | Tagged: Exchange Rates, Forward Premium Anomaly

Market Dynamics and the Forward Premium Anomoly: A Model of Interacting Agents

By Evan Myer

This paper presents a stochastic model of exchange rates, which is used to explain the forward premium anomaly. In the model, agents switch between four trading strategies, and these changes drive the evolution of the exchange rate. This framework is meant to more realistically represent the important market dynamics of exchange rates, as we suspect these to be the cause of the forward premium anomaly. Our simulations of the model indicate two conclusions: (i) many of the statistical regularities observed in currency markets, including the forward premium anomaly, can be thought of as macro-level scaling laws emerging from micro-level interactions of heterogeneous agents, and (ii) the dynamics of estimates of the beta coefficient in tests of UIP are driven by perceived relationships between changes in interest rates and agents’ aggregate views on the value of the exchange rate, which we call the fundamental value. Section I presents an introduction to the topic and section II reviews the relevant literature. Section III provides the theoretical basis of the forward premium anomaly and our model, then the mathematical definition of the model. Section IV presents the results of a typical simulation which section V compares to relevant stylized facts of the currency markets. Sections VI and VII present our results and a conclusion of what we have drawn from the model.

Honors Thesis

Advisor: Craig Burnside | JEL Codes: G1,G13, G15 | Tagged: Exchange Rates, Forward Premium Anomoly

Enhanced versus Traditional Indexation for International Mutual Funds: Evaluating DFA, Wisdom Tree and RAFI PowerShares

By Heehyun Lim

This paper uses stye analysis to compare the performance of traditional international index funds and enhanced international index funds. It attempts to measure the value added beyond classic indexation by the consideration of fundamentals. By employing Sharpe’s style analysis, I formulate a synthetic portfolio composed of DFA traditional funds to imitate each enhanced index fund portfolio’s performance. Then I compare the return and volatility of each portfolio. The result shows that half of enhanced fund portfolios tested in the paper outperforms their traditional synthetic portfolio, while the other half under-perform.

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Advisor: Edward Tower | JEL Codes: G11, G15 | Tagged: Enhanced Index Fund, Fundamental, Indexation, Style Analysis

Motivation and Reasoning Behind Chinese Enterprises Overseas Listing

By Sjing Liang

Starting from the early 90s, the number of Chinese firms going public overseas has been increasing rapidly. By running a probit regression, this paper investigates the different factors that affect a Chinese firm’s choice of listing location, either a domestic or a foreign stock exchange. Our data consists of 286 foreign listed companies and 788 domestically listed ones that went public between 2005 and the first quarter of 2011. Our results reveal that, larger firms, in terms of their pre-IPO revenue values, are more likely to go public overseas. In addition, firms in high-tech and capital-intensive industries, namely technology, financials, and real estate, are better represented in overseas markets. We also find that stock markets with lower underpricing levels are more attractive to Chinese firms, who tend to avoid capital markets with high underpricing levels as they do not want to be undervalued at their IPOs.

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Advisor: Alon Brav, Edward Tower | JEL Codes: G10, G15 | Tagged: Chinese Enterprises, Initial Public Offerings, Oversea Listing, Stock Markets

Volatility and Correlation Modeling for Sector Allocation in International Equity Markets

By Melanie Fan

Reliable estimates of volatility and correlation are crucial in asset allocation and risk management. This paper investigates Static, RiskMetrics, and Dynamic Conditional Correlation (DCC) models for estimating volatility and correlation by testing them in an asset allocation context. Optimal allocation weights for one year found using estimates from each model are carried to the subsequent year and the realized Sharpe ratio is computed to assess portfolio performance. We also study cumulative risk-adjusted returns over the entire sample period. Our ndings indicate that DCC does not consistently have an advantage over the other two models, although it is optimal in certain scenarios.

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Advisor: Aino Levonmaa, Emma Rasiel | JEL Codes: C32, C51, G11, G15 | Tagged: Asset Allocation, Dynamic Correlation, Emerging Markets, Volatilita

Taming the Dragon: The Modernization of the Chinese Equity Markets and its Effects on IPO Underpricing

By William Benesh

The extreme underpricing of Chinese Initial Public Offerings in the early days of the Chinese equity markets was reduced by several reforms instituted by the Chinese government from around 2000 to 2002. These reforms reduced 1-day returns on IPOs from 295% to 72%. The reforms reduced IPO underpricing by decreasing the inequality between IPO supply and demand. These reforms, while announced between 2000 and 2002, likely took until around 2004 to take full effect. In addition to inequality between supply and demand, other factors such as information asymmetry and government/quality signaling contributed to underpricing both before and after the reforms.

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JEL Codes: G14, G15, G28, G30 | Tagged: China, Initial Public Offerings, Regulation, Stock Markets, Underpricing

 

 

 

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Jennifer Becker
dus_asst@econ.duke.edu

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Michelle P. Connolly
michelle.connolly@duke.edu