I develop a model with two assets in which the hedging activity of derivatives dealers, interacting with market illiquidity, distorts the covariance structure of the market. I apply the model to hedging of counter party risk, and find strong support for the model's key predictions. Using evidence from Japan, I show that hedging of counterparty risk associated with currency swap portfolios drives a strong, non-fundamental correlation between credit and currency markets. The effects are economically significant. For example, I estimate that counter party risk hedging associated with SoftBank's FX swap portfolio accounts for 25% of the weekly volatility of SoftBank CDS returns.
{"title":"Hedging-Induced Correlation in Illiquid Markets","authors":"Søren Bundgaard Brøgger","doi":"10.2139/ssrn.3599477","DOIUrl":"https://doi.org/10.2139/ssrn.3599477","url":null,"abstract":"I develop a model with two assets in which the hedging activity of derivatives dealers, interacting with market illiquidity, distorts the covariance structure of the market. I apply the model to hedging of counter party risk, and find strong support for the model's key predictions. Using evidence from Japan, I show that hedging of counterparty risk associated with currency swap portfolios drives a strong, non-fundamental correlation between credit and currency markets. The effects are economically significant. For example, I estimate that counter party risk hedging associated with SoftBank's FX swap portfolio accounts for 25% of the weekly volatility of SoftBank CDS returns.","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"3 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-05-12","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116862640","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}
Ashish Garg, Christian Goulding, Campbell R. Harvey, M. Mazzoleni
We document and quantify the negative impact of trend breaks (i.e., turning points in the trajectory of asset prices) on the performance of standard trend-following strategies across several assets and asset classes. The frequency of trend breaks has increased in recent years, which can help explain the lower performance of monthly trend following in the last decade. We illustrate how to repair trend-following strategies by exploiting the return forecasting properties of the different types of trend breaks: market corrections and rebounds. We construct dynamic multi-asset trend-following portfolios, which harvest more than double the average returns of standard trend-following investing strategies over the last decade.Also see our related paper: Momentum Turning Points
{"title":"Breaking Bad Trends","authors":"Ashish Garg, Christian Goulding, Campbell R. Harvey, M. Mazzoleni","doi":"10.2139/ssrn.3594888","DOIUrl":"https://doi.org/10.2139/ssrn.3594888","url":null,"abstract":"We document and quantify the negative impact of trend breaks (i.e., turning points in the trajectory of asset prices) on the performance of standard trend-following strategies across several assets and asset classes. The frequency of trend breaks has increased in recent years, which can help explain the lower performance of monthly trend following in the last decade. We illustrate how to repair trend-following strategies by exploiting the return forecasting properties of the different types of trend breaks: market corrections and rebounds. We construct dynamic multi-asset trend-following portfolios, which harvest more than double the average returns of standard trend-following investing strategies over the last decade.Also see our related paper: Momentum Turning Points","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-05-07","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130158178","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 short essay discusses alternative methodologies that could be considered for handling swaptions whose underlying rates may transition to new risk-free rates before expiration. Note that the methodologies discussed in this response deals only with American-style swaptions. In an earlier response, the author discussed methodologies that could be used to handle European-style swaptions whose underlying rates are billed to transition to new rates before expiration. This analysis assumes that when LIBOR is eventually discontinued, its replacement will also avail a mechanism for constructing a forward-looking term structure of interest rates that market participants can use to price and value securities.
{"title":"Re: Consultation on Swaptions Impacted by the CCP Discounting Transition to the SOFR (FED)/Consultation on Swaptions Impacted by the CCP Discounting Transition From EONIA to the ESTR (ECB) – Part II on American Swaptions","authors":"Oluwaseyi (Tony) Awoga CPA, PRM","doi":"10.2139/ssrn.3742415","DOIUrl":"https://doi.org/10.2139/ssrn.3742415","url":null,"abstract":"This short essay discusses alternative methodologies that could be considered for handling swaptions whose underlying rates may transition to new risk-free rates before expiration. Note that the methodologies discussed in this response deals only with American-style swaptions. In an earlier response, the author discussed methodologies that could be used to handle European-style swaptions whose underlying rates are billed to transition to new rates before expiration. This analysis assumes that when LIBOR is eventually discontinued, its replacement will also avail a mechanism for constructing a forward-looking term structure of interest rates that market participants can use to price and value securities.","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"53 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-05-02","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126605996","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}
John Hua Fan, Adrian Fernández-Pérez, Ivan Indriawan, N. Todorova
Abstract We examine the impact of internationalization on the quality of Chinese iron ore and PTA futures markets, by comparing the trading activities, costs and volatilities before and after the event. Using a difference-in-difference framework, we find that internationalization improves the market quality for PTA, while the opposite effect occurs with iron ore futures. This difference is caused in part by the activities of hedgers and speculators, while decreases in the iron ore market quality are largely explained by the erosion of locational arbitrage opportunities. Since the effects of internationalization differ across commodities, its success must be assessed case by case.
{"title":"Internationalization of Futures Markets: Lessons from China","authors":"John Hua Fan, Adrian Fernández-Pérez, Ivan Indriawan, N. Todorova","doi":"10.2139/ssrn.3482205","DOIUrl":"https://doi.org/10.2139/ssrn.3482205","url":null,"abstract":"Abstract We examine the impact of internationalization on the quality of Chinese iron ore and PTA futures markets, by comparing the trading activities, costs and volatilities before and after the event. Using a difference-in-difference framework, we find that internationalization improves the market quality for PTA, while the opposite effect occurs with iron ore futures. This difference is caused in part by the activities of hedgers and speculators, while decreases in the iron ore market quality are largely explained by the erosion of locational arbitrage opportunities. Since the effects of internationalization differ across commodities, its success must be assessed case by case.","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"35 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-04-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116573158","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}
Recent empirical studies in Equity markets show evidence that, while asset log-returns are largely uncorrelated, it is possible to predict with some accuracy their future sign. Such prediction is made over a given forecast horizon based solely on the observed sign of the cumulative log-return over a lookback horizon. This manuscript proposes a methodology to study the impact of such findings on option pricing by embedding into the risk premium the effects of signed path dependence. This is achieved by devising a model-free empirical risk-neutral distribution based on Polynomial Chaos Expansions coupled with stochastic bridge interpolators that includes information from the entire set of observable European call option prices under all available strikes and maturities for a given underlying asset. Under the real-world measure we propose a price dynamics model that is compatible with an asset price process that is largely uncorrelated but still exhibits signed path dependence. The risk premium behaviour is subsequently inferred non-parametrically via a stochastic bridge interpolation that couples the risk neutral Polynomial Chaos Expansion result with the signed path dependence mixture binomial tree dynamic model to obtain a dynamic stochastic model for the implied risk premium process.
{"title":"Option Pricing with Polynomial Chaos Expansion Stochastic Bridge Interpolators and Signed Path Dependence","authors":"Fabio S. Dias, G. Peters","doi":"10.2139/ssrn.3588871","DOIUrl":"https://doi.org/10.2139/ssrn.3588871","url":null,"abstract":"Recent empirical studies in Equity markets show evidence that, while asset log-returns are largely uncorrelated, it is possible to predict with some accuracy their future sign. Such prediction is made over a given forecast horizon based solely on the observed sign of the cumulative log-return over a lookback horizon. This manuscript proposes a methodology to study the impact of such findings on option pricing by embedding into the risk premium the effects of signed path dependence. This is achieved by devising a model-free empirical risk-neutral distribution based on Polynomial Chaos Expansions coupled with stochastic bridge interpolators that includes information from the entire set of observable European call option prices under all available strikes and maturities for a given underlying asset. Under the real-world measure we propose a price dynamics model that is compatible with an asset price process that is largely uncorrelated but still exhibits signed path dependence. The risk premium behaviour is subsequently inferred non-parametrically via a stochastic bridge interpolation that couples the risk neutral Polynomial Chaos Expansion result with the signed path dependence mixture binomial tree dynamic model to obtain a dynamic stochastic model for the implied risk premium process.","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"198 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-04-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132306638","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}
Most of the financial litterature on optimal investment assumes that there exists both an initial and a final date between which the investment policy has to made optimal.. In practice, however, fund managers does not really have a starting point nor a final point at which the efficiency of their strategy can be assessed. The aim of this paper to explore the optimisation program of an open ended fund manager. Our contribution is twofold.
First we introduce an endogenous reference level process which replaces the traditional "initial value". This allows us to derive new state variables. Those state variables, which can be interpreted as averaged past returns, are well suited to formulate open-ended investment issues.
Second, combining the above with a random investment time, we formulate and solve the problem of how a wealth process can be made as close as possible to an option profile in an open-ended framework. In the risk-neutral limit, the result is obtained as the solution of an ODE. Some simulations illustrate the practical effectiveness of our approach.
{"title":"Generation of Option-Like Investment Profiles in Open-Ended Funds","authors":"Nicolas Gaussel, Benjamin Bruder","doi":"10.2139/ssrn.3586568","DOIUrl":"https://doi.org/10.2139/ssrn.3586568","url":null,"abstract":"Most of the financial litterature on optimal investment assumes that there exists both an initial and a final date between which the investment policy has to made optimal.. In practice, however, fund managers does not really have a starting point nor a final point at which the efficiency of their strategy can be assessed. The aim of this paper to explore the optimisation program of an open ended fund manager. Our contribution is twofold.<br><br>First we introduce an endogenous reference level process which replaces the traditional \"initial value\". This allows us to derive new state variables. Those state variables, which can be interpreted as averaged past returns, are well suited to formulate open-ended investment issues.<br><br>Second, combining the above with a random investment time, we formulate and solve the problem of how a wealth process can be made as close as possible to an option profile in an open-ended framework. In the risk-neutral limit, the result is obtained as the solution of an ODE. Some simulations illustrate the practical effectiveness of our approach.","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"65 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-04-27","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114802222","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}
There have been 91 defaults among U.S. CDS reference entities between 2002 and 2018. Within this sample, the five-year CDS spread significantly enhances the explanatory power of benchmark corporate default prediction models with equity market covariates and firm attributes, both in- and out-of-sample. This finding holds among financial and non-financial firms, and both within and without the great financial crisis. Moreover, the predictive power of the CDS spread is concentrated among entities with higher CDS market liquidity, while the illiquidity component of the CDS spread itself does not explain default. Lastly, neither the corporate bond yield spread nor CDS market indices explain default in the presence of firm-level CDS spreads. These results confirm the relevance of information contained in credit risk pricing to default prediction.
{"title":"Credit Derivatives and Corporate Default Prediction","authors":"Xiaoxia Ye, F. Yu, Ran Zhao","doi":"10.2139/ssrn.3578188","DOIUrl":"https://doi.org/10.2139/ssrn.3578188","url":null,"abstract":"There have been 91 defaults among U.S. CDS reference entities between 2002 and 2018. Within this sample, the five-year CDS spread significantly enhances the explanatory power of benchmark corporate default prediction models with equity market covariates and firm attributes, both in- and out-of-sample. This finding holds among financial and non-financial firms, and both within and without the great financial crisis. Moreover, the predictive power of the CDS spread is concentrated among entities with higher CDS market liquidity, while the illiquidity component of the CDS spread itself does not explain default. Lastly, neither the corporate bond yield spread nor CDS market indices explain default in the presence of firm-level CDS spreads. These results confirm the relevance of information contained in credit risk pricing to default prediction.","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"145 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-04-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114416949","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}
Expected returns on market volatility, which can be obtained from VIX futures in closed form, predict subsequent multi-period realized volatility returns. Expected volatility returns are negative on average, but become more negative after volatility increases. This generates a positive relation with subsequent realized returns on volatility, which are more negative following increases in volatility. Expected volatility returns also predict future index returns, because realized volatility returns are negatively correlated with realized index returns. We show how these results are related to existing results on the predictive power of the market variance risk premium, the slope of the VIX term structure, and the VIX premium. The results are robust to a wide range of variations in the empirical setup.
{"title":"Expected and Realized Returns on Volatility","authors":"Guanglian Hu, Kris Jacobs","doi":"10.2139/ssrn.3580539","DOIUrl":"https://doi.org/10.2139/ssrn.3580539","url":null,"abstract":"Expected returns on market volatility, which can be obtained from VIX futures in closed form, predict subsequent multi-period realized volatility returns. Expected volatility returns are negative on average, but become more negative after volatility increases. This generates a positive relation with subsequent realized returns on volatility, which are more negative following increases in volatility. Expected volatility returns also predict future index returns, because realized volatility returns are negatively correlated with realized index returns. We show how these results are related to existing results on the predictive power of the market variance risk premium, the slope of the VIX term structure, and the VIX premium. The results are robust to a wide range of variations in the empirical setup.","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"8 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-04-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123083592","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 : 2020-03-29DOI: 10.1146/ANNUREV-FINANCIAL-012820-033052
Patrick Augustin, M. Subrahmanyam
There is sufficient evidence in the popular, legal, and financial literatures that informed options trading ahead of scheduled and unexpected corporate events is pervasive. In this review, we piece...
{"title":"Informed Options Trading Before Corporate Events","authors":"Patrick Augustin, M. Subrahmanyam","doi":"10.1146/ANNUREV-FINANCIAL-012820-033052","DOIUrl":"https://doi.org/10.1146/ANNUREV-FINANCIAL-012820-033052","url":null,"abstract":"There is sufficient evidence in the popular, legal, and financial literatures that informed options trading ahead of scheduled and unexpected corporate events is pervasive. In this review, we piece...","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"104 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-03-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"117176562","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 Fix for precious metals is a global pricing benchmark that provides pricing and liquidity provision for market participants. We exploit the gradual change in the century old auction process to quantify the efficiencies related to more transparent pricing for several precious metals. Our focus is on the market impact of this change on exchange listed products. We find that reforms to the Fix structure have reduced quoted and effective bid-ask spreads for exchange traded futures contracts and improved overall market depth. The results imply a positive spillover effect stemming from more timely and accurate pricing information. The conditions under which we observe the benefits from transparency are related to product liquidity and the degree of market segmentation.
{"title":"Benchmarks in the Spotlight: The Impact on Exchange Traded Markets","authors":"Angelo Aspris, Sean Foley, Peter O’Neill","doi":"10.2139/ssrn.3562073","DOIUrl":"https://doi.org/10.2139/ssrn.3562073","url":null,"abstract":"The Fix for precious metals is a global pricing benchmark that provides pricing and liquidity provision for market participants. We exploit the gradual change in the century old auction process to quantify the efficiencies related to more transparent pricing for several precious metals. Our focus is on the market impact of this change on exchange listed products. We find that reforms to the Fix structure have reduced quoted and effective bid-ask spreads for exchange traded futures contracts and improved overall market depth. The results imply a positive spillover effect stemming from more timely and accurate pricing information. The conditions under which we observe the benefits from transparency are related to product liquidity and the degree of market segmentation.","PeriodicalId":293888,"journal":{"name":"Econometric Modeling: Derivatives eJournal","volume":"89 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-03-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124394641","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}
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