Essays on asset pricing, financial crisis, and market efficiency

This thesis broadly studies the questions related to asset pricing, financial crisis, and the role of the financial crisis in explaining the behavior of the studied financial markets in terms of market efficiency in line with the implications of the Adaptive Market Hypothesis. In this study, we specifically try to examine the aspects related to stocks, managed futures, and foreign exchange markets. The first study (Ch. 2) considers the effects of exchange rate changes on the returns of firms operating in the stock markets of transition emerging economies of central and eastern Europe along with incorporating the effects of recent financial crisis and integration with the EU. In this study, we examine the effects of exchange rate changes in their respective domestic currencies against USD / EUR on the performance of the central and eastern European firms operating either domestically or internationally. Results indicated that the firms in these economies are significantly exposed to exchange rate changes against both EUR/USD being more pronounced for EUR for Central and Eastern European firms and USD for Russia. The results of other effects are mixed making the analysis interesting for the readers. The second study (Ch. 3) examines the managed futures market and tries to explore the ability of the commodity trading advisors (CTAs) to provide investors with an important diversification benefit in times of crisis. we found that managed futures do acquire positive gains during crisis periods called “Crisis Alpha” and it stems due to their diversification and trend following nature. We also explore the average response time of CTAs to adjust their exposure during the crisis by reducing their exposure in the crisis sector by 50% in less than 15 days. The third study (Ch. 4) tests the long memory behavior of the foreign exchange markets in the emerging (18) and the developed (10) economies and used it to explain the behavior of these markets by the implications of the Adaptive Market Hypothesis (AMH). Our empirical results based on our static and dynamic DFA methodology (Peng et al. (1995)) indicate that most of the developed and emerging foreign exchange markets exhibit long memory. Further, the sub-sample analysis based on the financial crisis effects shows episodes of long memory and no long memory implying changes in the behavior of these markets resulting in the time-varying efficiency. Thus the behavior of these markets can be best explained by the evolutionary concept of market efficiency that is the adaptive market hypothesis. Our results have far-reaching implications for investment decision-making, as they emphasize that country-specific along with asset-specific characteristics play an important role in the financial decision-making process. Furthermore, it also highlights an important aspect of managed future returns characteristics, that the source of crisis alpha of CTA’s is not only limited to the diversification principle but also due to the quick downward positioning in their respective crisis market. Finally, we also showed that the efficiency of financial markets particularly the forex market has been evolved over a period due to the changes in the behavior of the market participants consistent with the implications of AMH, which opens ways to incorporate behavioral elements / sentimental analysis by practitioners or investors while modeling for financial assets valuation for efficient investment handling.

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