Asian Review of Financial Research

pISSN: 1229-0351
eISSN: 2713-6531

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Asian Review of Financial Research / May 2017 Vol. 30 No. 2

Static-Price-Range Volatility Interruptions on the KRX : Characteristics, Price Stabilization, and Price Discovery

Ilchan Ahn;Sung Chae La;Jong-Ho Park;Kyong Shik Eom

Asian Review of Financial Research :: Vol.30 No.2 pp.103-142

Abstract
Static-Price-Range Volatility Interruptions on the KRX : Characteristics, Price Stabilization, and Price Discovery ×

“A volatility interruption (VI) is a sophisticated microstructure mechanism providing cooling-off periods and effective price discovery functionalities in brief periods of abnormal volatility for an individual stock” (Eom, Ra, Park, and Ahn, 2015). VIs consist of two types: dynamic and static. The dynamic VI is invoked when a price fluctuation due to a single order exceeds a predetermined range, e.g., ±2% in the Korea Exchange (KRX). The static VI is activated when a cumulative price fluctuation due to multiple orders and transactions exceeds a predetermined range, e.g., ±10%. On September 1, 2014, KRX preemptively adopted the dynamic VI. Then, on June 15, 2015, the exchange additionally introduced the static VI while simultaneously expanding the price limit to ±30% to alleviate a wider range of price changes. In this paper, focusing on the adoption that occurred on June 15, 2015, we examine whether the newly introduced static VI, in addition to the existing dynamic VI, produces economic benefits consistent with the purpose of introducing VIs, such as price stabilization and discovery. In this process, we also identify the characteristics involved in dynamic and static VI invocations and discuss what type of VIs or price stabilization mechanisms are best suited to the Korean stock market. The related domestic and foreign papers are limited in number. The unique feature of this paper is the direct comparative analysis of the economic effectiveness of both dynamic and static VIs. We were able to perform this analysis because KRX adopted the dynamic and static VIs consecutively. In addition, the price-limit system, which is unique to the Korean stock market, allows us to discuss the economic relationship between the static VI and price limit. We analyze 1,937 stocks listed on the KOSPI and KOSDAQ markets in KRX over 2 periods of 48 trading days each before and after June 15, 2015, when the static VI was introduced. The previous period denotes the period when only the dynamic VI was implemented, and the latter period refers to the period when both the dynamic and static VIs were implemented in tandem with an increase of the price limit to ±30%. The results of our analyses using trade and quote data are as follows. First, the stocks for which the static VI is invoked are mainly small and medium-sized, low-priced, and highly volatile, as are those for which the dynamic VI is invoked. Unlike the dynamic VI, however, the static VI tends to be invoked more frequently as trading volume increases, suggesting that the static VI invocation is a phenomenon that occurs when investors' opinions vary. The static VI is invoked more often than the dynamic VI in terms of the number of stocks or frequencies. Second, there is little relation between dynamic VI invocation and the hit occurrence of upper and lower limits. Meanwhile, the static VI has a significant influence on the hit occurrence of upper and lower limits in direction and magnitude. This suggests that the static VI plays a role in enforcing narrow upper and lower limits. However, assuming that the intrinsic volatility of the KOSPI and KOSDAQ markets remained constant, the expansion of the price limit to ±30% appears to have increased the realized volatility of these markets by about 14~15%. Third, the price stabilization and price discovery effects of the dynamic VI are fairly solid, and the effects themselves are consistent regardless of the introduction of the static VI or the expansion of the price limit. These effects are also almost the same quantitatively and qualitatively as those of the dynamic VI that was adopted in September 2014. The static VI, in contrast, appears to contribute to some degree to price discovery, but greatly impairs price stability. This is attributable to the static VI and price limit, which function fairly similarly, being implemented at the same time. The VI system in Korea was adopted to eventually replace the existing price-limit system, which has been evaluated as ineffective in preventing temporarily abnormal fluctuations in prices that may occur in high-frequency trading, manipulative trading, etc. Our results show that the dynamic VI is serving its intended purposes relatively well, while the static VI has a significant negative impact on price stability. This seems to be due to a conflict between the designed functionality of the static VI and its practical role as a narrow upper and lower price limit within the existing price-limit system. In addition, the dynamic VI has a limited effect on the establishment of an equilibrium price immediately after the VI invocation period in cases where the stock price overshoots to a remarkable level just before the dynamic VI invocation. Therefore, in-depth verification of the various parameters (e.g., ±10% variation in the static VI) that constitute the specific activating requirements of the dynamic and static VIs adopted by KRX is advised.

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Static-Price-Range Volatility Interruptions on the KRX : Characteristics, Price Stabilization, and Price Discovery ×
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Bi-directional Analysis of Short Selling Activities before Analyst Recommendation Changes

Tae-Jun Park;Pyoung-Hoon Chang

Asian Review of Financial Research :: Vol.30 No.2 pp.143-180

Abstract
Bi-directional Analysis of Short Selling Activities before Analyst Recommendation Changes ×

By empirically testing short selling activities that occur before changes in analysts' recommendations, this paper examines the “informed front-running hypothesis” that predicts an abnormal decrease (increase) of short selling before analyst upgrades (downgrades). According to Blau and Wade's (2012) conceptual framework, this study divides analyst recommendation changes into analyst upgrades and downgrades and uses four measures of abnormal short turnover used in Christophe et al. (2010) and Blau and Wade (2012). This study shows that abnormal shorting increases significantly before both downgrades and upgrades. After dividing the sample into KOSPI and KOSDAQ categories based on market type, domestic and foreign analysts' recommendation changes, and investor type (institutions, foreigners, and individuals), the study finds no evidence that short sellers have the ability to acquire information about upcoming recommendation changes before the information becomes publicly available. The study also finds that pre-recommendation short selling does not predict upcoming events. These findings disprove the informed front-running hypothesis and are generally consistent with Blau and Wade's (2012) argument that short selling before recommendation changes is more likely to be speculative than informed.

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External Shocks and the Heterogeneous Autoregressive Model of Realized Volatility

Cheoljun Eom;Uk Chang;Jong Won Park

Asian Review of Financial Research :: Vol.30 No.2 pp.181-216

Abstract
External Shocks and the Heterogeneous Autoregressive Model of Realized Volatility ×

This study investigates the effect of external shocks on stock market volatility, focusing on improving the explanatory power and prediction ability of the heterogeneous autoregressive model of realized volatility (HAR-RV) using intraday high-frequency 5-minute return data from the KOSPI market index over the period from January 2004 to June 2016. Based on previous studies, we use improved methods in our empirical design to enhance the reliability of the empirical results: a method extracting jump components from measurements of realized volatility based on statistical significance evaluation; a method incorporating nighttime market information (without trading) into the measurements of realized volatility; a method assessing whether to improve the prediction ability of a proposed model through statistical significance evaluation; and a robustness test comparing the proposed model with models containing well-known explanatory variables of the volatility leverage effect and realized skewness and kurtosis. This study creates time series data on the external shock variable (ES) using principal components analysis by combining the selected 10-type variables that have the property of external shocks in the international financial markets, raw material markets, and commodity markets. It then uses the ES variable in empirical tests. The main results are as follows. First, the ES variable created from the principal components analysis does well at reflecting large changes in international markets. Second, the ES variable has a significant Granger causality relationship to the realized volatility over the whole period, while each of the selected 10-type variables has a significant causality relationship only for the specific periods of interest. Third, from the perspective of in-sample analysis, the HAR-RV model with the ES variable significantly improves the explanatory power of changes in the future realized volatility. In the out-of-sample analysis, the ES variable has the significant information value of enhancing the predictive power of the model in future periods. Finally, these are robust results regardless of whether the volatility leverage effect and realized skewness/kurtosis variables are included in the HAR-RV model. Our results show robust evidence that the external shocks have meaningful information value for explaining and predicting changes in future volatility in the HAR-RV model, and imply that the methodology of constructing the ES variable may provide new directions for future research using the HAR-RV model.

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Discretionary Consumption and the Equity Premium : Evidence from Korea

Jaehoon Hahn,Yong Joo Kang,Yuna Sohn

Asian Review of Financial Research :: Vol.30 No.2 pp.217-236

Abstract
Discretionary Consumption and the Equity Premium : Evidence from Korea ×

Aït-Sahalia, Parker, and Yogo (2004) suggest using luxury goods retail sales data as an alternative measure of consumption to obtain more reasonable estimates for the coefficient of relative risk aversion that better match the observed equity premium. We apply their novel idea of using data that reflect discretionary consumption by the wealthy to the Korean context by using sales revenue of three largest sellers of high-end whisky and two major airlines as proxies for discretionary consumption that are more likely to respond to movements in the stock market. When theses proxies for discretionary consumption are used in place of standard consumption, the estimates for relative risk aversion are an order of magnitude smaller and economically plausible, similar to the findings reported by Aït-Sahalia et al. (2004) for the United States.

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