Recent Research: Highlights from June 2010
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"A Valuation Study of Stock Market Seasonality and the Size Effect." The Journal of Portfolio Management, Spring 2010. Zhiwu Chen and Jan Jindra.
Existing studies on market seasonality and the size effect are largely based on realized returns. In this article, Chen and Jindra investigate seasonal variations and size-related differences in a cross-stock valuation distribution. They use three stock valuation measures, two derived from structural models and one from the book-to-market ratio. The authors find that the average valuation level is highest in mid-summer and lowest in mid-December. Furthermore, the valuation dispersion (kurtosis) across stocks increases toward year-end and reverses direction after the turn of the year, suggesting increased movements in both the underand overvaluation directions. Among size groups, small-cap stocks exhibit the sharpest decline in valuation from June to December and the highest rise from December to January. For most months, small-cap stocks have the lowest valuation among all size groups and show the widest cross-stock valuation dispersion, meaning that they are also the hardest to value. Overall, large-cap stocks enjoy the highest valuation uniformity and are the least subject to valuation seasonality.
In addition to its role as the optimal ex ante combination of risky assets for a risk-averse investor, possessing the highest potential return-for-risk trade-off, the tangency or maximum Sharpe ratio portfolio in the Markowitz [1952, 1991] procedure plays an important role in asset management because it minimizes the probability that a future portfolio return falls below the risk-free, or reference, rate; this is a kind of Value at Risk (VaR) property of the portfolio. In this article the authors demonstrate the way this VaR, and related quantities, vary along the efficient frontier, emphasizing the special role played by the tangency portfolio. The results are illustrated with an analysis of the market crash of October 1987, as an episode of extreme negative market movements, in which the tangency portfolio performs best (loses least!) among a variety of portfolios.
Residential mortgage markets in certain developing nations have grown in sophistication and complexity to the point where they now resemble the U.S. model: Instead of a single financial institution originating, servicing and holding all the risk of a mortgage loan, loan markets in Argentina, Brazil, and Mexico, for example, have begun to “unbundle” these functions. This is yielding benefits for lenders and home borrowers as well as mortgage security investors, as risks are appropriately passed on to end borrowers and new loan products are generated, among other benefits. Yet this evolution is in some cases also creating challenges for these national mortgage markets, including interest-rate, inflation, and foreign-currency risks, as well as legal hurdles for investors. This article surveys the unbundling of emerging-market mortgage markets and establishes a legal and investment framework for creating sound, home-loan and secondary mortgage-security markets.