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Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk
 THE JOURNAL OF FINANCE • VOL. LVI
, 2001
"... This paper uses a disaggregated approach to study the volatility of common stocks at the market, industry, and firm levels. Over the period 1962–1997 there has been a noticeable increase in firmlevel volatility relative to market volatility. Accordingly, correlations among individual stocks and the ..."
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Cited by 509 (17 self)
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This paper uses a disaggregated approach to study the volatility of common stocks at the market, industry, and firm levels. Over the period 1962–1997 there has been a noticeable increase in firmlevel volatility relative to market volatility. Accordingly, correlations among individual stocks and the explanatory power of the market model for a typical stock have declined, whereas the number of stocks needed to achieve a given level of diversification has increased. All the volatility measures move together countercyclically and help to predict GDP growth. Market volatility tends to lead the other volatility series. Factors that may be responsible for these findings are suggested.
Recovering Risk Aversion from Option Prices and Realized Returns. Manuscript
, 1998
"... A relationship exists between aggregate riskneutral and subjective probability distributions and risk aversion functions. Using a variation of the method developed by Jackwerth and Rubinstein (1996), we estimate riskneutral probabilities reliably from option prices. Subjective probabilities are es ..."
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Cited by 196 (8 self)
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A relationship exists between aggregate riskneutral and subjective probability distributions and risk aversion functions. Using a variation of the method developed by Jackwerth and Rubinstein (1996), we estimate riskneutral probabilities reliably from option prices. Subjective probabilities are estimated from realized returns. This paper then introduces a technique to empirically derive risk aversion functions implied by option prices and realized returns simultaneously. These risk aversion functions dramatically change shapes around the 1987 crash: Precrash, they are positive and decreasing in wealth and thus consistent with standard economic theory. Postcrash, they are partially negative and increasing and irreconcilable with the theory. Overpricing of outofthemoney puts is the most likely cause. A simulated trading strategy exploiting this overpricing shows excess returns even after accounting for the possibility of further crashes and transaction costs. * Jens Carsten Jackwerth is a visiting assistant professor at the London Business School. For helpful discussions I
Seniority and Maturity of Debt Contracts
 Journal of Financial Economics
, 1993
"... This paper provides a model of how borrowers with private information about their credit prospects choose seniority and maturity of debt. Increased shortterm debt leads lenders to liquidate too often. It also increases the sensitivity of financing costs to new information, although betterthanaver ..."
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Cited by 139 (4 self)
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This paper provides a model of how borrowers with private information about their credit prospects choose seniority and maturity of debt. Increased shortterm debt leads lenders to liquidate too often. It also increases the sensitivity of financing costs to new information, although betterthanaverage borrowers desire information sensitivity. The model implies that shortterm debt will be senior to longterm debt, and that longterm debt will allow the issue of additional future senior debt. The model also has implications on the structure of leveraged buyouts and on how various types of lenders respond to potential defaults. 1.
Towards a Theory of Volatility Trading
 Reprinted in Option Pricing, Interest Rates, and Risk Management, Musiella, Jouini, Cvitanic
, 1998
"... Introduction ffl Three methods have evolved for trading vol: 1. static positions in options eg. straddles 2. deltahedged option positions 3. volatility swaps ffl The purpose of this talk is to explore the advantages and disadvantages of each approach. ffl I'll show how the first two methods ..."
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Cited by 119 (15 self)
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Introduction ffl Three methods have evolved for trading vol: 1. static positions in options eg. straddles 2. deltahedged option positions 3. volatility swaps ffl The purpose of this talk is to explore the advantages and disadvantages of each approach. ffl I'll show how the first two methods can be combined to create the third. ffl I'll also show the link between some "exotic" volatility swaps and some recent work by Dupire[3] and Derman, Kani, and Kamal[2]. Part I Static Positions in Options Trading Vol via Static Positions in Options ffl The classic position for trading vol is an atthemoney straddle. ffl Unfortunately, the position loses sensitivity to vol as the underlying moves away from the strike. ffl Is there a static options position which maintains its sensitivity to vol as the underlying moves? ffl To answer this q
Optionimplied Riskneutral Distributions and Implied Binomial Trees: A Literature Review
 JOURNAL OF DERIVATIVES
, 1999
"... In this partial and selective literature review of option implied riskneutral distributions and of implied binomial trees, we start by observing that in efficient markets, there is information contained in option prices, which might help us to design option pricing models. To this end, we review ..."
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Cited by 73 (3 self)
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In this partial and selective literature review of option implied riskneutral distributions and of implied binomial trees, we start by observing that in efficient markets, there is information contained in option prices, which might help us to design option pricing models. To this end, we review the numerous methods of recovering riskneutral probability distributions from option prices at one particular timetoexpiration and their applications. Next, we extend our attention beyond one timetoexpiration to the construction of implied binomial trees, which model the stochastic process of the underlying asset. Finally, we describe extensions of implied binomial trees, which incorporate stochastic volatility, as well as other nonparametric methods.
Robust Hedging of the Lookback Option
, 1998
"... The aim of this article is to find bounds on the prices of exotic derivatives, and in particular the lookback option, in terms of the (market) prices of call options. This is achieved without making explicit assumptions about the dynamics of the price process of the underlying asset, but rather by i ..."
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Cited by 67 (11 self)
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The aim of this article is to find bounds on the prices of exotic derivatives, and in particular the lookback option, in terms of the (market) prices of call options. This is achieved without making explicit assumptions about the dynamics of the price process of the underlying asset, but rather by inferring information about the potential distribution of asset prices from the call prices. Thus the bounds we obtain and the associated hedging strategies are model independent. The appeal and significance of the hedging strategies arises from their universality and robustness to model misspecification. 1 Call Options as Traded Assets Trading in call options is now so liquid that some authors (including Dupire [5, 6]) have argued that calls should no longer be treated as derivative assets to be priced using a BlackScholes model (or otherwise). Instead calls should be treated as primary assets, whose prices are fixed exogenously by market sentiments. It is only more complicated continge...
An introduction to general equilibrium with incomplete asset markets
, 1990
"... I survey the major results in the theory of general equilibrium with incomplete asset markets. I also ..."
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Cited by 57 (0 self)
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I survey the major results in the theory of general equilibrium with incomplete asset markets. I also
Neglected risks, financial innovation, and financial fragility
 Journal of Financial Economics
, 2011
"... We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second, investors demand securities with safe cash flows. F ..."
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Cited by 38 (3 self)
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We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second, investors demand securities with safe cash flows. Financial intermediaries cater to these preferences and beliefs by engineering securities perceived to be safe but exposed to neglected risks. Because the risks are neglected, security issuance is excessive. As investors eventually recognize these risks, they fly back to safety of traditional securities and markets become fragile, even without leverage, precisely because the volume of new claims is excessive.
Spanning and Completeness with Options
 Review of Financial Studies
, 1988
"... The role of ordinary options in facilitating the completion of securities markets is examined in the context of a model of contingent claims sufficiently general to accommodate the continuous distributions of asset pricing theory and option pricing theory. In this context, it is shown that call opti ..."
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Cited by 21 (0 self)
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The role of ordinary options in facilitating the completion of securities markets is examined in the context of a model of contingent claims sufficiently general to accommodate the continuous distributions of asset pricing theory and option pricing theory. In this context, it is shown that call options written on a single security approximately span all contingent claims written on this security and that call options written on portfolios of call options on individual primitive securities approximately span all contingent claims that can be written on these primitive securities. In the case of simple options, explicit formulas are given for the approximating options and portfolios of options. These results are applied to the pricing of contingent claims by arbitrage and to irrelevance propositions in corporate finance. The role of complete contingentclaims markets in the optimal allocation of risk bearing is well known [Arrow (1964) and Debreu (1959)] and is the cornerstone of the economic theory of financial markets [Mossin (1977)]. As a consequence, it becomes important from a practical as well as a scholarly perspective to determine how complex the securities markets must be in order to achieve the allocational efficiencies of complete markets. The literature on this question has grown to be sizable. Much of this literature has been reviewed in John (1981, 1984) and Amershi (1985). A seminal contribution concerning the complexity of complete securities markets was made by Ross (1976) in analyzing the role of conventional options in com
Systemic Risk and Regulation
 The Risks of Financial Institutions
, 2006
"... Historically, much of the banking regulation that was put in place was designed to reduce systemic risk. In many countries capital regulation in the form of the Basel agreements is currently one of the most important measures to reduce systemic risk. In recent years there has been considerable growt ..."
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Cited by 18 (0 self)
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Historically, much of the banking regulation that was put in place was designed to reduce systemic risk. In many countries capital regulation in the form of the Basel agreements is currently one of the most important measures to reduce systemic risk. In recent years there has been considerable growth in the transfer of credit risk across and between sectors of the financial system. In particular there is evidence that risk has been transfered from the banking sector to the insurance sector. One argument is that this is desirable and simply reflects diversification opportunities. Another is that it represents regulatory arbitrage and the concentration of risk that may result from this could increase systemic risk. This paper shows that both scenarios are possible depending on whether markets and contracts are complete or incomplete. We are grateful to our discussant Charles Calomiris and other participants at the