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FEATURED IN PROFESSIONAL INVESTOR [WINTER 2007]
Abstract
There is overwhelming evidence that the expectations hypothesis (EH) does not describe how long yields are determined in practice. We take this evidence at face value and ask how long yields might be set, if not by the EH. We explore the possibility that the EH fails because short yield expectations are subject to behavioral biases, rather than because the hypothesis that long yields are determined by expected short rates is false. To explore this idea, we draw on the well-established literature on behavioral finance that has been developed to explain the stylized features of short-term momentum and long-term return reversals in equity returns. We focus on two particular classes of behavioral models – those based on the representativeness bias and the conservatism bias – and derive the testable implications of these models for expectations in the bond market. In contrast with the equity market – where the markets’ expectations of earnings are not observable – expectations of the short yield can be imputed from the term structure of interest rates. The bond market therefore offers a valuable opportunity to directly test the implications of behavioral models for expectational errors. We find that the predictions of these models are strongly supported by the data, suggesting that investors in the bond market are indeed subject to these behavioral biases.
To read the paper, click HERE.
Anirut Pisedtasalasai (University of Canterbury, New Zealand)
FEATURED IN PROFESSIONAL INVESTOR [WINTER 2007]
Abstract
In this paper, the authors investigate return and volatility spillover effects between large and small stocks in the UK stock market using the multivariate AR-GJR GARCH-M model. They find that the returns and volatilities of large stocks are important in predicting the future dynamics of smaller stocks, but that the returns and volatilities of smaller stocks have much less impact on the future dynamics of large stocks. Their empirical results suggest that information flow has an influence on the pattern of the transmission mechanisms between large and small stocks. Market-wide information is first incorporated into the prices of large stocks before being impounded into the prices of small stocks.
To read the paper, click HERE.
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Can Behavioural Finance Explain the Term Structure Puzzles?
George Bulkley, Richard D. F. Harris, Vivekanand NawosahFEATURED IN PROFESSIONAL INVESTOR [WINTER 2007]
Abstract
There is overwhelming evidence that the expectations hypothesis (EH) does not describe how long yields are determined in practice. We take this evidence at face value and ask how long yields might be set, if not by the EH. We explore the possibility that the EH fails because short yield expectations are subject to behavioral biases, rather than because the hypothesis that long yields are determined by expected short rates is false. To explore this idea, we draw on the well-established literature on behavioral finance that has been developed to explain the stylized features of short-term momentum and long-term return reversals in equity returns. We focus on two particular classes of behavioral models – those based on the representativeness bias and the conservatism bias – and derive the testable implications of these models for expectations in the bond market. In contrast with the equity market – where the markets’ expectations of earnings are not observable – expectations of the short yield can be imputed from the term structure of interest rates. The bond market therefore offers a valuable opportunity to directly test the implications of behavioral models for expectational errors. We find that the predictions of these models are strongly supported by the data, suggesting that investors in the bond market are indeed subject to these behavioral biases.
To read the paper, click HERE.
Return and Volatility Spillovers Between Large and Small Stocks in the UK
Richard D. F. HarrisAnirut Pisedtasalasai (University of Canterbury, New Zealand)
FEATURED IN PROFESSIONAL INVESTOR [WINTER 2007]
Abstract
In this paper, the authors investigate return and volatility spillover effects between large and small stocks in the UK stock market using the multivariate AR-GJR GARCH-M model. They find that the returns and volatilities of large stocks are important in predicting the future dynamics of smaller stocks, but that the returns and volatilities of smaller stocks have much less impact on the future dynamics of large stocks. Their empirical results suggest that information flow has an influence on the pattern of the transmission mechanisms between large and small stocks. Market-wide information is first incorporated into the prices of large stocks before being impounded into the prices of small stocks.
To read the paper, click HERE.
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