This paper tests the counter-cyclicality of aggregate risk aversion and price of market risk using a novel testing approach introduced in Antell and Vaihekoski (2015) for conditional asset pricing models. Cohen et al. (2015) report experimental evidence that the risk aversion is countercyclical, although empirical support from financial studies is at best inconclusive. This paper applies the new testing approach for the Merton (1973, 1980) model with time-varying risk aversion. The testable implications link realized equity premium to, among others, changes in conditional variance, its long-term persistence, and changes in the time-varying risk aversion. Empirically, testing is conducted using monthly US stock market data from 1928 to 2013, and using (asymmetric) GARCH models to estimate conditional variance. We compare various methods to model economic expectations regarding the state of the economy. Unlike the traditional estimation approach, the results from the new estimation approach give support for time-varying and countercyclical behavior for the risk aversion.
{"title":"Countercyclical and Time-Varying Risk Aversion and the Equity Premium","authors":"J. Antell, M. Vaihekoski","doi":"10.2139/ssrn.2753537","DOIUrl":"https://doi.org/10.2139/ssrn.2753537","url":null,"abstract":"This paper tests the counter-cyclicality of aggregate risk aversion and price of market risk using a novel testing approach introduced in Antell and Vaihekoski (2015) for conditional asset pricing models. Cohen et al. (2015) report experimental evidence that the risk aversion is countercyclical, although empirical support from financial studies is at best inconclusive. This paper applies the new testing approach for the Merton (1973, 1980) model with time-varying risk aversion. The testable implications link realized equity premium to, among others, changes in conditional variance, its long-term persistence, and changes in the time-varying risk aversion. Empirically, testing is conducted using monthly US stock market data from 1928 to 2013, and using (asymmetric) GARCH models to estimate conditional variance. We compare various methods to model economic expectations regarding the state of the economy. Unlike the traditional estimation approach, the results from the new estimation approach give support for time-varying and countercyclical behavior for the risk aversion.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"489 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-10-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115300638","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
A method is presented to estimate and decompose a portfolio's risk along independent factors. This decomposition is based upon a market's underlying independent risk factors, which are found empirically by using an inductive causal search algorithm that is based on independent component analysis. Since independent risk factors can be understood to always add risk to a portfolio, a portfolio manager can use them to better understand and budget risk. In contrast, portfolio management using the classic marginal analysis is confusing because adding a risky security to a portfolio might actually reduce the portfolio's risk. In a small application using the six most widely traded currencies (the Australian dollar, Canadian dollar, euro, sterling, Japanese yen and US dollar), independent-factor risk contributions are constrained during portfolio optimizations, and the internal risk characteristics of the resulting portfolios are found to compare favorably with those created by using constraints on the risk contributions of the original assets.
{"title":"Decomposition of Portfolio Risk into Independent Factors Using an Inductive Causal Search Algorithm","authors":"Brian D. Deaton","doi":"10.21314/jor.2016.341","DOIUrl":"https://doi.org/10.21314/jor.2016.341","url":null,"abstract":"A method is presented to estimate and decompose a portfolio's risk along independent factors. This decomposition is based upon a market's underlying independent risk factors, which are found empirically by using an inductive causal search algorithm that is based on independent component analysis. Since independent risk factors can be understood to always add risk to a portfolio, a portfolio manager can use them to better understand and budget risk. In contrast, portfolio management using the classic marginal analysis is confusing because adding a risky security to a portfolio might actually reduce the portfolio's risk. In a small application using the six most widely traded currencies (the Australian dollar, Canadian dollar, euro, sterling, Japanese yen and US dollar), independent-factor risk contributions are constrained during portfolio optimizations, and the internal risk characteristics of the resulting portfolios are found to compare favorably with those created by using constraints on the risk contributions of the original assets.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"13 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-10-05","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128812436","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We present a general and path-consistent wrong-way risk (WWR) model, which does not require simulation of credit and market variables simultaneously. Although similar so-called copula models are well known, our approach is novel in several ways. First, our method can model a wide range of dependence structures while always guaranteeing path consistency of default probabilities (the possibility of path-inconsistencies in copula models was highlighted in a recent article). Second, we place special emphasis on the difficult task of calibrating the underlying dependence structure. In particular, we consider a default correction of the dependence structure. Third, our model serves as a bridge between structural model approaches, where dependence between exposure and equity price is modeled, and copula models, where exposure is directly correlated to default time. Finally, we apply our method in realistic situations and show that we can achieve a wide range of WWR impacts.
{"title":"Path-Consistent Wrong-Way Risk: A Structural Model Approach","authors":"Markus Hofer","doi":"10.21314/jor.2016.343","DOIUrl":"https://doi.org/10.21314/jor.2016.343","url":null,"abstract":"We present a general and path-consistent wrong-way risk (WWR) model, which does not require simulation of credit and market variables simultaneously. Although similar so-called copula models are well known, our approach is novel in several ways. First, our method can model a wide range of dependence structures while always guaranteeing path consistency of default probabilities (the possibility of path-inconsistencies in copula models was highlighted in a recent article). Second, we place special emphasis on the difficult task of calibrating the underlying dependence structure. In particular, we consider a default correction of the dependence structure. Third, our model serves as a bridge between structural model approaches, where dependence between exposure and equity price is modeled, and copula models, where exposure is directly correlated to default time. Finally, we apply our method in realistic situations and show that we can achieve a wide range of WWR impacts.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"31 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-10-05","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115058391","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This study investigates if market risk-based capital requirements (MRR) implemented in 1998 mitigated bank risk associated with trading activities. Recognizing that only banks with sufficiently high trading activities are subject to the MRR (regulated), we implement a difference-in-difference (DID) approach to show that in the post-MRR period, unregulated banks experienced an increase in risk associated with trading activity, while their regulated counterparts enjoyed no appreciable change in trading-related risk. We interpret the resulting negative DID coefficient as evidence of a risk-mitigating effect of the MRR. We also show that upon the implementation of the MRR, unregulated banks exhibit a significantly larger increase in contribution of opaque trading activity to bid-ask spreads, compared to regulated banks, for which the association between trading activity and bid-ask spreads actually declines. Our results are consistent with the view that the MRR significantly reduced moral hazard and adverse selection problems associated with opaque trading activities.The views expressed in this paper are those of the authors alone and do not necessarily reflect the views of the Board of Governors of the Federal Reserve System, the Federal Reserve System, or their staff.
{"title":"Market Risk-Based Capital Requirements, Trading Activity, and Bank Risk","authors":"Dmytro Holod, Yuriy Kitsul, Gokhan Torna","doi":"10.2139/ssrn.2846409","DOIUrl":"https://doi.org/10.2139/ssrn.2846409","url":null,"abstract":"This study investigates if market risk-based capital requirements (MRR) implemented in 1998 mitigated bank risk associated with trading activities. Recognizing that only banks with sufficiently high trading activities are subject to the MRR (regulated), we implement a difference-in-difference (DID) approach to show that in the post-MRR period, unregulated banks experienced an increase in risk associated with trading activity, while their regulated counterparts enjoyed no appreciable change in trading-related risk. We interpret the resulting negative DID coefficient as evidence of a risk-mitigating effect of the MRR. We also show that upon the implementation of the MRR, unregulated banks exhibit a significantly larger increase in contribution of opaque trading activity to bid-ask spreads, compared to regulated banks, for which the association between trading activity and bid-ask spreads actually declines. Our results are consistent with the view that the MRR significantly reduced moral hazard and adverse selection problems associated with opaque trading activities.The views expressed in this paper are those of the authors alone and do not necessarily reflect the views of the Board of Governors of the Federal Reserve System, the Federal Reserve System, or their staff.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"115 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-09-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127222912","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The challenge in long volatility strategies is to minimize the cost of carrying such insurance due to negative roll yields and negative volatility risk premia. This study proposes a hedging strategy for volatility as an asset class that provides substantial protection against market crashes, while still participating upside preservation. The results show (i) timely hedging strategy removes the extreme negative tail risk and reduces the negative skewness in exchange for slightly fewer instances of large positive returns; (ii) dynamic allocation effectively mitigates the negative cost-of-carry problem; (iii) using volatility contracts as extreme downside hedges can be a viable alternative to buying out-of-the-money SP and (iv) the significant volatility-hedged return is a form of compensation for investable higher-moment equity risk factors.
{"title":"Volatility Derivatives and Downside Risk","authors":"Yueh‐Neng Lin","doi":"10.2139/ssrn.2826647","DOIUrl":"https://doi.org/10.2139/ssrn.2826647","url":null,"abstract":"The challenge in long volatility strategies is to minimize the cost of carrying such insurance due to negative roll yields and negative volatility risk premia. This study proposes a hedging strategy for volatility as an asset class that provides substantial protection against market crashes, while still participating upside preservation. The results show (i) timely hedging strategy removes the extreme negative tail risk and reduces the negative skewness in exchange for slightly fewer instances of large positive returns; (ii) dynamic allocation effectively mitigates the negative cost-of-carry problem; (iii) using volatility contracts as extreme downside hedges can be a viable alternative to buying out-of-the-money SP and (iv) the significant volatility-hedged return is a form of compensation for investable higher-moment equity risk factors.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"132 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-08-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114615986","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2016-08-01DOI: 10.17016/FEDS.2016.065r1
Dobrislav Dobrev, T. Nesmith, D. Oh
We provide an accurate closed-form expression for the expected shortfall of linear portfolios with elliptically distributed risk factors. Our results aim to correct inaccuracies that originate in Kamdem (2005) and are present also in at least thirty other papers referencing it, including the recent survey by Nadarajah et al. (2014) on estimation methods for expected shortfall. In particular, we show that the correction we provide in the popular multivariate Student t setting eliminates understatement of expected shortfall by a factor varying from at least four to more than 100 across different tail quantiles and degrees of freedom. As such, the resulting economic impact in financial risk management applications could be significant. We further correct such errors encountered also in closely related results in Kamdem (2007 and 2009) for mixtures of elliptical distributions. More generally, our findings point to the extra scrutiny required when deploying new methods for expected shortfall estimation in practice.
{"title":"Accurate Evaluation of Expected Shortfall for Linear Portfolios with Elliptically Distributed Risk Factors","authors":"Dobrislav Dobrev, T. Nesmith, D. Oh","doi":"10.17016/FEDS.2016.065r1","DOIUrl":"https://doi.org/10.17016/FEDS.2016.065r1","url":null,"abstract":"We provide an accurate closed-form expression for the expected shortfall of linear portfolios with elliptically distributed risk factors. Our results aim to correct inaccuracies that originate in Kamdem (2005) and are present also in at least thirty other papers referencing it, including the recent survey by Nadarajah et al. (2014) on estimation methods for expected shortfall. In particular, we show that the correction we provide in the popular multivariate Student t setting eliminates understatement of expected shortfall by a factor varying from at least four to more than 100 across different tail quantiles and degrees of freedom. As such, the resulting economic impact in financial risk management applications could be significant. We further correct such errors encountered also in closely related results in Kamdem (2007 and 2009) for mixtures of elliptical distributions. More generally, our findings point to the extra scrutiny required when deploying new methods for expected shortfall estimation in practice.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"3 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-08-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127735067","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper investigates international cointegration and financial integration among equity market indexes using index option data, providing an ex-ante analysis through investor anticipations. Daily time series of risk-neutral variance, skewness, and kurtosis are constructed for five major indexes for three sub-periods between 2003 and 2013. Fractionally cointegrated VAR models are estimated at the international level, accounting for persistence in risk-neutral moments. Our results show that there exist international equilibria in risk-neutral moments defined by several cointegrating vectors. During the 2007–2009 global crisis period, these equilibria are characterized by an increase in persistence and in the speeds of adjustment. Moreover, for risk-neutral variance and skewness, all markets are included in the equilibria and none are weakly exogenous. Outside the global crisis period, the cointegration relationship is more fragmented, especially for higher-order moments. In particular, crash and tail risks are segmented during the European debt crisis.
{"title":"International Stock Market Cointegration Under the Risk-Neutral Measure","authors":"Marie‐Hélène Gagnon, G. Power, D. Toupin","doi":"10.2139/ssrn.2815528","DOIUrl":"https://doi.org/10.2139/ssrn.2815528","url":null,"abstract":"This paper investigates international cointegration and financial integration among equity market indexes using index option data, providing an ex-ante analysis through investor anticipations. Daily time series of risk-neutral variance, skewness, and kurtosis are constructed for five major indexes for three sub-periods between 2003 and 2013. Fractionally cointegrated VAR models are estimated at the international level, accounting for persistence in risk-neutral moments. Our results show that there exist international equilibria in risk-neutral moments defined by several cointegrating vectors. During the 2007–2009 global crisis period, these equilibria are characterized by an increase in persistence and in the speeds of adjustment. Moreover, for risk-neutral variance and skewness, all markets are included in the equilibria and none are weakly exogenous. Outside the global crisis period, the cointegration relationship is more fragmented, especially for higher-order moments. In particular, crash and tail risks are segmented during the European debt crisis.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"508 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-07-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123424613","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Intuitively, option-like compensation contracts induce risk-shifting behavior, confirmed by numerous empirical studies. However, theoretical work has shown that risk shifting should not happen without a definite expiration date of the option. With a sample of Commodity Trading Advisors (CTAs), we show that increases in risk (interpreted as risk shifting) correspond to even greater increases in return, as shown by increasing Sharpe ratios. Second, controlling for expected returns eliminates measured risk shifting. Finally, measured risk shifting behavior, strong between 1994 and 2003, is substantially lower or missing from 2004 to 2014. Thus, we conclude that CTAs are increasing risk adjusted returns, not risk shifting, confirming the theoretical results.
{"title":"Risk Shifting or Just Risk-Adjusted Returns","authors":"J. Blocher, Cheng Jiang, Marat Molyboga","doi":"10.2139/ssrn.2802171","DOIUrl":"https://doi.org/10.2139/ssrn.2802171","url":null,"abstract":"Intuitively, option-like compensation contracts induce risk-shifting behavior, confirmed by numerous empirical studies. However, theoretical work has shown that risk shifting should not happen without a definite expiration date of the option. With a sample of Commodity Trading Advisors (CTAs), we show that increases in risk (interpreted as risk shifting) correspond to even greater increases in return, as shown by increasing Sharpe ratios. Second, controlling for expected returns eliminates measured risk shifting. Finally, measured risk shifting behavior, strong between 1994 and 2003, is substantially lower or missing from 2004 to 2014. Thus, we conclude that CTAs are increasing risk adjusted returns, not risk shifting, confirming the theoretical results.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"20 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-03-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121393295","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We examine the optimal customization of a financial derivative in the presence of a background risk. This problem includes the model of finding the optimal constant amount of a given pecuniary risk as a degenerated case. We show the importance of this perspective with a preference-free solution for the pecuniary background risk case and a general solution for any given utility function. The latter solution allows us to measure the incompleteness premium demanded by risk-averse agent for a market where only constant amount of risk is allowed in comparison with a complete and arbitrage-free market where the customization is unrestricted.
{"title":"Customizable Pecuniary Risk and Market Incompleteness Premium","authors":"Yiyong Yuan","doi":"10.2139/ssrn.2745267","DOIUrl":"https://doi.org/10.2139/ssrn.2745267","url":null,"abstract":"We examine the optimal customization of a financial derivative in the presence of a background risk. This problem includes the model of finding the optimal constant amount of a given pecuniary risk as a degenerated case. We show the importance of this perspective with a preference-free solution for the pecuniary background risk case and a general solution for any given utility function. The latter solution allows us to measure the incompleteness premium demanded by risk-averse agent for a market where only constant amount of risk is allowed in comparison with a complete and arbitrage-free market where the customization is unrestricted.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"4 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-03-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130289158","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2016-02-09DOI: 10.20472/EFC.2016.005.002
Tariq Aziz, V. Ansari
The relation between idiosyncratic risk and stock returns is currently a topic of debate in the academic literature. So far the evidence regarding the relation is mixed. This study aims to investigate the cross-sectional relation between idiosyncratic risk and stock returns in the Indian stock market employing quantile regressions. Using quantile regressions, this study demonstrates that idiosyncratic volatility and stock returns relation is quantile dependent. The relation between idiosyncratic volatility and stock returns is parabolic. The high idiosyncratic risk is associated with high (low) excess returns at the upper (lower) quantile of the conditional distribution. This partially explains the inconclusive evidence on the idiosyncratic volatility and the stock returns relation in the literature.
{"title":"Idiosyncratic Risk and Stock Returns: A Quantile Regression Approach","authors":"Tariq Aziz, V. Ansari","doi":"10.20472/EFC.2016.005.002","DOIUrl":"https://doi.org/10.20472/EFC.2016.005.002","url":null,"abstract":"The relation between idiosyncratic risk and stock returns is currently a topic of debate in the academic literature. So far the evidence regarding the relation is mixed. This study aims to investigate the cross-sectional relation between idiosyncratic risk and stock returns in the Indian stock market employing quantile regressions. Using quantile regressions, this study demonstrates that idiosyncratic volatility and stock returns relation is quantile dependent. The relation between idiosyncratic volatility and stock returns is parabolic. The high idiosyncratic risk is associated with high (low) excess returns at the upper (lower) quantile of the conditional distribution. This partially explains the inconclusive evidence on the idiosyncratic volatility and the stock returns relation in the literature.","PeriodicalId":187811,"journal":{"name":"ERN: Other Econometric Modeling: Capital Markets - Risk (Topic)","volume":"89 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-02-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124535631","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
京公网安备 11010802042870号
京ICP备2023020795号-1
扫码关注我们
求助内容：
应助结果提醒方式：