Secrets of Finances and Payday Loans

Loan prices take continuous values

admin — Sun, 14 Feb 2010 23:30:59 +0000

In the rest of this blog three models will be outlined in which the choice between limit and market orders is the key element of traders’ optimization strategies. The model by Parlour (1998) concentrates on the time priority rule, which governs limit order books, and shows how the choice between market and limit orders depends crucially on the state of both sides of the book at the time the order is submitted. Foucault’s (1999) model of price formation focuses instead on the winner’s curse problem, which arises when limit order submitters cannot cancel their orders and, due to the arrival of public information, run the risk of being picked off by incoming traders submitting market orders. In the model by Foucault, Kadan and Kandel (2005) the determinants of the price formation process and of the strategic order submission choice are instead the speed of agents’ arrival on the market, their waiting costs and the relative number of patient and impatient traders. Although the work is not presented in this chapter, the reader should be aware that Rosu (2004) extends the Foucault, Kadan and Kandel model by allowing both limit order traders to cancel their orders and prices to take continuous values.

Payday loans and equity market performance

admin — Fri, 30 Oct 2009 22:13:33 +0000

The high correlation between M&A activity and equity market performance clearly shows that M&A was a major driver of the equity bubble of the late 1990s. Sometimes even mergers that did not create synergies were rewarded by rising stock prices on the side of the overtaking parties. It was obvious that not every merger was going to increase operating profitability.

Yet, the degrees of freedom in goodwill accounting helped to grow earnings per share without actually increasing profit levels. At the height of the equity bubble, investors encouraged companies to use their own overvalued equity to pay for the overvalued assets of another company.

Reasons that explain the credit spread differential

admin — Thu, 29 Oct 2009 20:03:08 +0000

But the more cyclical character of the US market and the lower average credit quality of the issuers are not the only reasons that explain the spread differential. Another reason is the different investor base. It was already pointed out that the European corporate bond market is still young, while the US market is well developed and has attracted a broad base of institutional investors. Those investors are usually very concerned about markto-market losses, and therefore their decisions are driven by short-term considerations. Furthermore, hedge funds have been very active in the US corporate bond market over the last years. Both issues have helped to increase volatility. However, with the growing liquidity of the European corporate bond market and the increased professionality of investors, this differential probably will diminish.

The average credit quality of the issuers

admin — Wed, 28 Oct 2009 19:59:01 +0000

From the industry structure it becomes obvious that the average credit quality of the issuers in the US investment grade market is lower than in the Euro corporate bond market. The current rating of the Euro market is A, whereas it is only A_ in the US market. Over the last 5 years this differential has fluctuated between 1 and 2 notches. This helps to explain the wider spreads generally observed in the US corporate bond market. Additionally, US corporate bond spreads have been substantially more volatile than their Euro peers. Especially in times of weak equity markets and rising implied equity volatility the US market tends to underperform.

This is due to the fact that lower rated bonds are usually closer to the default threshold. Therefore, the put option on the assets of the company is more sensitive to changes in equity price and volatility.

Changes in the payday interest-rate environment

admin — Tue, 27 Oct 2009 18:42:35 +0000

A comparison of the sector structure of the Euro and US dollar corporate bond markets shows that the share of financials is much higher in the Euro market. While financial companies are somewhat cyclical, especially with respect to changes in the interest-rate environment, they are usually considered a rather defensive sector. The same holds true for the utility sector. Thus, it becomes very clear that the Euro corporate bond market as a whole is less exposed to the economic environment than the US market. However, we have not analyzed the industrial sector so far. Here, the picture is mixed. While the Euro market has a higher weight of automotive companies, the other cyclical sectors, such as basic industries, capital goods, consumer and services cyclical, media and technology, generally have a higher share in the US market.

The structure and assessment of loans market

admin — Mon, 26 Oct 2009 17:36:23 +0000

The assessment of the macroeconomic environment results in a judgement of the stage of the business cycle and the leverage cycle. Valuation indicators help to form an opinion on the future direction of credit spreads. However, the magnitude of a change in spreads essentially depends on the market structure, especially the average credit quality and the share of cyclical sectors. Lower average quality of the issues or a higher portion of cyclical industries typically results in a higher volatility of credit spreads, and therefore higher mark-to-market risk. Rational investors should require an additional risk premium for investing in a more volatile market, as an additional spread provides a cushion against adverse market movements.

Utility-maximizing behavior of real estate investors

admin — Sun, 25 Oct 2009 16:14:07 +0000

Tversky and Kahneman and Shiller argue that the assumption of rational, utility-maximizing behavior of investors is frequently violated in real life. They also show that these anomalies can be predicted and that they result from the use of simple heuristics to facilitate the process of decision-making. Sophisticated investors can benefit from this fact if they are able to predict changes in the direction of risk appetite correctly. In particular, reversals in risk appetite often correspond with turning points in the direction of spreads. Risk appetite indicators may also be a useful tool for major asset allocation decisions such as stocks versus bonds, value versus growth stocks or emerging markets versus developed markets.

The level of credot risk appetite in the preceding month

admin — Sat, 24 Oct 2009 14:08:41 +0000

Changes in risk appetite seem to depend on the level of risk appetite in the preceding month. Up- and downswings of risk appetite are driven by investors’ perceptions. If risky assets have outperformed for some time, investors tend to expect a continuation of this outperformance. Conversely, during times of underperformance of risky assets, investors apparently recall the downside risks associated with higher yielding assets. At the height of the equity bubble in March 2000, for example, riskier assets had been performing better than safer assets, whereas at the ‘panic’ low in October 2002, riskier assets had been performing worse. It should be noted that reversals seem to become more and more likely as risk appetite reaches extreme levels. For example, having made a panic low CSFB’s Global Risk Appetite Index usually reenters the euphoria zone in roughly 12–18 months. This index is calculated as the slope of a weighted regression of the returns of a broad range of assets from across the global risk spectrum against their historical return volatility. At a ‘euphoric’ peak as in March 2000, riskier assets had been performing a lot better than safer assets, whereas at a ‘panic’ low such as October 2002, riskier assets had been performing worse. Kindleberger describes the periods when the risk appetite reaches extremes as ‘distress’. He notes that in the extreme zone there appears to be an increased probability that events, which normally would be ignored by financial markets, trigger a reversal of the cycle.

The problems with risky payday classes

admin — Fri, 23 Oct 2009 13:51:17 +0000

Geopolitical risks like war and terror can create stress scenarios for all risky asset classes. The geopolitical situation has a strong impact on the risk aversion of investors. The events of September 11, 2001, provide a tragic example after which investors bought safe haven assets such as government bonds and gold at the cost of risky asset classes. Very risky and illiquid asset classes are particularly sensitive to changes in risk appetite. In times of growing risk appetite, more volatile and hence riskier assets perform well as investors become more willing to tolerate risk in exchange for higher expected returns. When risk appetite is falling, the reverse happens as risk premia rise and funds flow to safer assets. Consequently, special attention has to be paid in periods of high uncertainty. The most important indicators for risk aversion should be observed regularly. Among the most common indicators are implied volatilities and put/call ratios on equity options and options on interest rate future. The relative performance of growth and value stocks or high and low beta stocks can also help to estimate risk appetite. Gold and oil prices, too, often react quickly to changes in the geopolitical environment. Intermarket comparisons of the performance and volatility of different asset classes not only indicate changes in the riskloving attitude of investors, but also contain valuable information about the relative attractivity of certain markets. However, some of the abovementioned indicators may temporarily be distorted through demand and supply dynamics, or through a lack of liquidity.

The role of changes in investors’ credit risk appetite

admin — Thu, 22 Oct 2009 12:45:04 +0000

Market participants often cite changes in investors’ risk appetite as a possible explanation for developments in global financial markets that cannot be explained by changes of market fundamentals. Indeed, financial crises often seem to coincide with abrupt shifts in market sentiment from risk tolerance to risk avoidance. While fundamentals undoubtedly remain of significant importance, these shifts are likely to reflect the effective risk attitude as manifested through the behavior of active investors. But behavior similar to that induced by shifts in the fundamental preferences of investors over risk and return can also reflect changes in the composition of active market players or tactical trading patterns. Theoreticians like Kumar and Persaud argue that investors’ risk appetite not only changes over time, but also that these changes can be measured. If included in fundamentally based econometric models, risk appetite can lead to more accurate forecasts of market developments. Tools that track the dynamics of investors’ willingness to take on risks can lead to a better understanding of the functioning of financial markets. In particular, they can supplement the risk management of institutional investors. Sophisticated models therefore aim to distill a measure for risk appetite from a broad spectrum of sufficiently liquid assets. By taking various assets from across the global risk spectrum, a comprehensive comparison of the returns that they have offered relative to risk can be made.