This paper investigates to what extent globalization and regional integration lead to increasing equity market interdependence. I focus on Western Europe, as this region has gone through a unique period of economic, financial, and monetary integration. More specifically, I quantify the magnitude and time-varying nature of volatility spillovers from the aggregate European (EU) and U.S. market to 13 local European equity markets. To account for time-varying integration, I use a regime-switching model to allow the shock sensitivities to change over time. I find regime switches to be both statistically and economically important. Both the EU and U.S. shock spillover intensity increased substantially over the 1980s and 1990s, though the rise is more pronounced for EU spillovers. Shock spillover intensities increased most strongly in the second half of the 1980s and the first half of the 1990s. I show that increased trade integration, equity market development, and low inflation contribute to the increase in EU shock spillover intensity. I also find evidence for contagion from the U.S. market to a number of local European equity markets during periods of high world market volatility.

[We study the economic sources of stock-bond return comovements and their time variation using a dynamic factor model. We identify the economic factors employing a semistructural regime-switching model for state variables such as interest rates, inflation, the output gap, and cash flow growth. We also view risk aversion, uncertainty about inflation and output, and liquidity proxies as additional potential factors. We find that macroeconomic fundamentals contribute little to explaining stock and bond return correlations but that other factors, especially liquidity proxies, play a more important role. The macro factors are still important in fitting bond return volatility, whereas the "variance premium" is critical in explaining stock return volatility. However, the factor model primarily fails in fitting covariances.]

This paper investigates whether or not functionally diversified banks have a comparative advantage in terms of long-term performance/risk profile compared to their specialized competitors. To that end, this study uses market-based measures of return potential and bank risk. We calculate the franchise value over time of European banks as a measure of their long-run performance potential. In addition, we measure risk as both the systematic and the idiosyncratic risk components derived from a bank stock return model. Finally, we analyze the return/risk trade-off implied in different functional diversification strategies using a panel data analysis over the period 1989–2004. A higher share of non-interest income in total income affects banks’ franchise values positively. Diversification of revenue streams from distinct financial activities increases the systematic risk of banks while the effect on the idiosyncratic risk component is non-linear and predominantly downward-sloping. These findings have conflicting implications for different stakeholders, such as investors, bank shareholders, bank managers and bank supervisors.

We compare default rates on conventional and Islamic loans using a comprehensive monthly dataset from Pakistan that follows more than 150,000 loans over the period 2006:04 to 2008:12. We find robust evidence that the default rate of Islamic loans is less than half the default rate of conventional loans. Islamic loans are less likely to default during Ramadan and in big cities if the share of votes to religious-political parties increases, suggesting that religion – either through individual piousness or network effects – may play a role in determining loan default.

This paper uses Bayesian Model Averaging to examine the driving factors of equity returns of US Bank Holding Companies. BMA has as an advantage over OLS that it accounts for the considerable uncertainty about the correct set (model) of bank risk factors. We find that out of a broad set of 12risk factors only the market, real estate, and high-minus-low Fama–French factors are reliably related to US bank stock returns over the period 1986–2010. Other factors are either only relevant over specific subperiods or for subsets of bank holding companies. We discuss the implications of our findings for empirical banking research.

We study the economic sources of stock-bond return comovements and their time variation using a dynamic factor model. We identify the economic factors employing a semistructural regime-switching model for state variables such as interest rates, inflation, the output gap, and cash flow growth. We also view risk aversion, uncertainty about inflation and output, and liquidity proxies as additional potential factors. We find that macroeconomic fundamentals contribute little to explaining stock and bond return correlations but that other factors, especially liquidity proxies, play a more important role. The macro factors are still important in fitting bond return volatility, whereas the "variance premium" is critical in explaining stock return volatility. However, the factor model primarily fails in fitting covariances. (JEL G11, G12, G14, E43, E44) Stock and bond returns in the United States display an average correlation of about 19% during the post-1968 period. Shiller and Beltratti (1992) underestimate the empirical correlation using a present value with constant discount rates, whereas Yet, these models generate realistically positive correlations using economic state variables.

We identify flight-to-safety (FTS) days for twenty-three countries using only stock and bond returns and a model averaging approach. FTS days comprise less than 2% of the sample and are associated with a 2.7% average bond-equity return differential and significant flows out of equity funds and into government bond and money market funds. FTS represents flights to both quality and liquidity in international equity markets, but mainly a flight to quality in the U.S. corporate bond market. Emerging markets, endowment funds, and hedge funds perform poorly during FTS, whereas hedge funds appear to vary their systematic exposures prior to an FTS.

We develop a tractable equilibrium asset pricing model with cumulative prospect theory (CPT) preferences. Using GMM on a sample of U.S. equity index option returns, we show that by introducing a single common probability weighting parameter for both tails of the return distribution, the CPT model can simultaneously generate the otherwise puzzlingly low returns on both out-of-the-money put and out-of-the-money call options as well as the high observed variance premium. In a dynamic setting, probability weighting and time-varying equity return volatility combine to match the observed time-series pattern of the variance premium. Received May 30, 2017; editorial decision August 10, 2018 by Editor Andrew Karolyi.