Informational Efficiency in Distressed Markets: The Case of European Corporate Bonds
Universitat Rovira i Virgili – Department of Business
National University of the South – Instituto de Investigaciones Económicas y Sociales del Sur (IIESS)
The Economic and Social Review, Vol. 45, No. 3, Autumn, 2014, pp. 349-369
This paper investigates the effect of the 2008 financial crisis on informational efficiency by carrying out a long-memory analysis of European corporate bond markets. We compute the Hurst exponent for fifteen sectorial indices to scrutinize the time-varying behavior of long-range memory, applying a shuffling technique to avoid short-term correlation. We find that the financial crisis has uneven effects on the informational efficiency of all corporate bond sectors, especially those related to financial services. However, their vulnerability is not homogeneous and some non-financial sectors suffer only a transitory effect.
Informational Efficiency In Distressed Markets: The Case Of European Corporate Bonds – Introduction
The study of informational efficiency, a cornerstone of which is the Efficient Market Hypothesis (EMH), is possibly one of the most elusive issues in financial economics. Its origins can be traced back to Gibson (1889), who wrote that the prices of publicly traded shares “may be regarded as the judgment of the best intelligence regarding them”. In spite of the fact that one of the first models of an informationally efficient market (Bachelier, 1900) was based on the price changes of French government bonds, the literature focused on the study of stock markets rather than bond markets.
However, the systematic study of informational efficiency was taken up in the 1960s, when financial economics emerged as a new area within economics. Fama’s classic definition (Fama, 1976) states that a market is informationally efficient if it “fully reflects all available information”. Therefore, the key element in assessing efficiency is to determine the appropriate set of information that drives prices. Following Fama (1970), informational efficiency can be divided into three categories: (i) weak efficiency, if prices reflect the information contained in past series of prices; (ii) semi-strong efficiency, if prices reflect all public information; and (iii) strong efficiency, if prices reflect all public and private information. As a corollary of EMH, the presence of long memory in financial time series cannot be accepted because it would allow risk-free profitable trading strategies. If markets are informationally efficient, arbitrage prevents the possibility of such strategies. Ross (2005) indicates that this definition leads one to believe that prices are the result of decisions made by individual agents and that they therefore depend on underlying information. As a corollary, higher returns cannot be obtained with the same information set. This implies that future returns depend to a great extent not only on historic information but also on new information received by the market. Therefore no investor whose information set is the same as or inferior to the market’s information set can beat the market.
In a recent paper Bariviera et al. (2012) study the impact of the crisis on corporate and sovereign bond markets of seven European countries, with similar results being found in all the countries examined. The interesting finding that the crisis brings about an enhancement of informational efficiency in sovereign bond indices and a deterioration in corporate bond indices leads us to carry out a more detailed study of the effect of the crisis on the informational efficiency of corporate bonds. According to Bariviera et al. (2012), there do not appear to be any country-specific characteristics that
influence informational efficiency. We therefore select a tout-court European corporate bond index for each economic sector in order to detect the permeability of certain sectors to crisis influence, as reflected in their informational efficiency.
The aim of this paper is to analyze the time-varying dynamics of informational efficiency as measured by the long memory of time series and the impact of the 2008 financial crisis on fifteen sectorial indices of European corporate bonds. This article contributes to the literature on EMH in four important aspects. First, we expand the empirical studies by analyzing the long memory of corporate bond indices. Second, we perform a comparative analysis of the most important and most recognized sectors of the economy. Third, we throw some light on the uneven impact of the 2008 financial crisis
across sectors. And fourth, we analyse the European market, where the most visible effects have taken place and which emerges as an alternative financing source for companies.
The paper is organised as follows. Section II presents a brief review of the literature on long memory in corporate bond markets. Section III introduces the Hurst exponent as a measure for long-range dependence and the corresponding break point relating to structural changes in the time series. Section IV presents the data and methodology used in the paper. Section V sets out the empirical results. Finally, Section VI contains the main conclusions.
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