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35
Unspanned stochastic volatility and the pricing of commodity derivatives
 Rev. Financial Studies
, 2009
"... Abstract We conduct a comprehensive analysis of unspanned stochastic volatility in commodity markets in general and the crudeoil market in particular. We present modelfree results that strongly suggest the presence of unspanned stochastic volatility in the crudeoil market. We then develop a trac ..."
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Cited by 25 (2 self)
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Abstract We conduct a comprehensive analysis of unspanned stochastic volatility in commodity markets in general and the crudeoil market in particular. We present modelfree results that strongly suggest the presence of unspanned stochastic volatility in the crudeoil market. We then develop a tractable model for pricing commodity deriva
Common Risk Factors in Currency Markets
, 2008
"... Currency excess returns are highly predictable and strongly countercyclical. The average excess returns on low interest rate currencies are 4.8 percent per annum smaller than those on high interest rate currencies after accounting for transaction costs. A single returnbased factor, the return on t ..."
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Cited by 23 (0 self)
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Currency excess returns are highly predictable and strongly countercyclical. The average excess returns on low interest rate currencies are 4.8 percent per annum smaller than those on high interest rate currencies after accounting for transaction costs. A single returnbased factor, the return on the highest minus the return on the lowest interest rate currency portfolios, explains the crosssectional variation in average currency excess returns from low to high interest rate currencies. In a simple affine pricing model, we show that the highminuslow currency return measures that component of the stochastic discount factor innovations that is common across countries. To match the carry trade returns in the data, low interest rate currencies need to load more on this common innovation when the market price of global risk is high.
2012, ‘Bond Liquidity Premia
 Review of Financial Studies
"... Recent models of limits to arbitrage imply that the tightness of funding conditions faced by financial intermediaries is a component of the pricing kernel. In the US, the repo market is the key funding market for traders and arbitrageurs implying in turn that the ontherun premium shares a common c ..."
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Cited by 16 (1 self)
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Recent models of limits to arbitrage imply that the tightness of funding conditions faced by financial intermediaries is a component of the pricing kernel. In the US, the repo market is the key funding market for traders and arbitrageurs implying in turn that the ontherun premium shares a common component with the risk premia observed in other markets. This observation leads to the following identification strategy. We measure the value of liquidity from the crosssection of ontherun premia by adding a liquidity factor to an arbitragefree term structure model. As predicted, we find that liquidity value affects the crosssection of risk premia at quarterly and annual horizons. An increase in the value of liquidity predicts lower risk premia for ontherun and offtherun bonds but higher risk premia on Libor loans, swap contracts and corporate bonds. Moreover, the measured impact is pervasive through crisis and normal times. Finally, we find that liquidity value varies with changes in aggregate uncertainty, measured from S&P500 options, and with changes in monetary stance, measured from bank reserves and monetary aggregates. These linkages are consistent with the theory and suggest that different securities serve, in part, and to varying degrees, to fulfill investors ’ uncertain future needs for cash.
Leverage effect, volatility feedback, and selfexciting market disruptions: Disentangling the multidimensional variations
 City University of New York
, 2008
"... Abstract Equity index volatility variation and its interaction with the index return can come from three distinct channels. First, index volatility increases with the market's aggregate financial leverage. Second, positive shocks to systematic risk increase the cost of capital and reduce the v ..."
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Cited by 7 (2 self)
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Abstract Equity index volatility variation and its interaction with the index return can come from three distinct channels. First, index volatility increases with the market's aggregate financial leverage. Second, positive shocks to systematic risk increase the cost of capital and reduce the valuation of future cash flows, generating a negative correlation between the index return and its volatility, regardless of financial leverage. Finally, large negative market disruptions show selfexciting behaviors. This paper proposes a model that incorporates all three channels and examines their relative contribution to index option pricing, as well as to stock option pricing for different types of companies. JEL classification: C51;G12; G13; G32.
The behavior of risk and market prices of risk over the nasdaq bubble period, Management Science 56
, 2010
"... W e exploit the information in the options market to study the variations of return risk and market prices of different sources of risk during the rise and fall of the Nasdaq market. We specify a model that accommodates fluctuations in both risk levels and market prices of different sources of risk ..."
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Cited by 5 (1 self)
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W e exploit the information in the options market to study the variations of return risk and market prices of different sources of risk during the rise and fall of the Nasdaq market. We specify a model that accommodates fluctuations in both risk levels and market prices of different sources of risk, and we estimate the model using the timeseries returns and option prices on the Nasdaq 100 tracking stock. Our analysis reveals three key variations during the period from March 1999 to March 2001. First, return volatility increased together with the rising Nasdaq index level, even though the two tend to move in opposite directions. Second, although the market price of diffusion return risk averages around 1.82 over the whole sample, the estimates reached negative territory at the end of 1999. The estimates reverted back to highly positive values after the collapse of the Nasdaq market. Third, the market price of jump risk increased with the rising Nasdaq valuation, and this increase in market price coincided with an increased imbalance in open interest between put and call options.
Sequential calibration of options
 Computational Statistics and Data Analysis
"... Abstract Robust calibration of option valuation models to quoted option prices is nontrivial, but as important for good performance as the valuation model itself. The standard textbook approach to option calibration is minimization of a suitably chosen measure of the prediction error, e.g. least sq ..."
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Cited by 4 (1 self)
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Abstract Robust calibration of option valuation models to quoted option prices is nontrivial, but as important for good performance as the valuation model itself. The standard textbook approach to option calibration is minimization of a suitably chosen measure of the prediction error, e.g. least squares minimization. This paper interpretes the total prediction error as a sum of the measurement errors and effects from the parameter dynamics. We introduce an apriori dynamics for the parameters. This will allow the parameters to change over time, while treating the measurement noise in a statistically consistent way and using all data efficiently. We here use models for which closed form expressions or Fourier transform methods are available, e.g. exponential Levy processes or certain stochastic volatility models. We use the Heston, Bates and NIGCIR models in this paper. We investigate the performance and computational efficiency of standard and iterated Extended Kalman filters (EKF and IEKF) as well as Particle Filters (PF). These methods are then compared to the common practice calibration method of Weighted Least Squares (WLS) and penalised Weighted Least Squares (PWLS). Our simulation study, using the Heston model, has shown that the introduced filter framework is capable of tracking time varying parameters and latent processes such as stochastic volatility processes. We find that the filter estimates and the PWLS estimates are much closer to the true parameters than the WLS estimates. When we use the same parameters to price Binary options we find that the prices obtained using the WLS estimates are inferior to those obtained by the other methods. When pricing exotic derivatives using models calibrated on European call option data we believe that the filter methods will perform better than the WLS. We also apply nonlinear filtering methods to daily European call option data on the S&P500 stock index. If we price options, using yesterdays estimated parameters and todays estimated latent process and todays stock price there is a general decrease in global fit over all models and all methods. This tendency is most pronounced for the WLS method indicating overfitting. We therefore find that there is need for adaptive calibration methods to handle time varying parameters in an accurate and robust way.
Crash risk in currency markets
, 2009
"... Abstract Since the Fall of 2008, outofthe money puts on high interest rate currencies have become significantly more expensive than outofthemoney calls, suggesting a large crash risk of those currencies. To evaluate crash risk precisely, we propose a parsimonious structural model that includes ..."
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Cited by 3 (0 self)
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Abstract Since the Fall of 2008, outofthe money puts on high interest rate currencies have become significantly more expensive than outofthemoney calls, suggesting a large crash risk of those currencies. To evaluate crash risk precisely, we propose a parsimonious structural model that includes both Gaussian and disaster risks and can be estimated even in samples that do not contain disasters. Estimating the model for the 1996 to 2014 sample period using monthly exchange rate spot, forward, and option data, we obtain a realtime index of the compensation for global disaster risk exposure. We find that disaster risk accounts for more than a third of the carry trade risk premium in advanced countries over the period examined. The measure of disaster risk that we uncover in currencies proves to be an important factor in the crosssectional and timeseries variation of exchange rates, interest rates, and equity tail risk.
Tail and volatility indices from option prices. Working paper
, 2013
"... Both volatility and the tail of stock return distributions are impacted by discontinuities or large jumps in the stock price process. In this paper, we construct a modelfree jump and tail index by measuring the impact of jumps on the Chicago Board Options Exchange’s VIX index. Our jump and tail ind ..."
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Cited by 3 (0 self)
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Both volatility and the tail of stock return distributions are impacted by discontinuities or large jumps in the stock price process. In this paper, we construct a modelfree jump and tail index by measuring the impact of jumps on the Chicago Board Options Exchange’s VIX index. Our jump and tail index is constructed from a portfolio of riskreversals using 30day index options, and measures time variations in the intensity of return jumps. Using the index, we document a 50fold increase in jump fears during the financial crisis, and that jump fears predict index returns after controlling for stock return variability.
VAR Modeling for Dynamic Loadings Driving Volatility Strings
, 2008
"... The implied volatility of an option as a function of strike price and time to maturity forms a volatility surface. Traders price according to the dynamics of this high dimensional surface. Recent developments that employ semiparametric models approximate the implied volatility surface (IVS) in a fi ..."
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Cited by 2 (2 self)
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The implied volatility of an option as a function of strike price and time to maturity forms a volatility surface. Traders price according to the dynamics of this high dimensional surface. Recent developments that employ semiparametric models approximate the implied volatility surface (IVS) in a finite dimensional function space, allowing for a low dimensional factor representation of these dynamics. This paper presents an investigation into the stochastic properties of the factor loading times series using the vector autoregressive (VAR) framework and analyzes associated movements of these factors with movements in economic indicators.
A SentimentBased Explanation of the Forward Premium Puzzle *
, 2011
"... This paper presents a sentimentbased explanation of the forward premium puzzle. Agents over or underestimate the growth rate of the economy. All else equal, when perceived domestic growth is higher than perceived foreign growth, the domestic interest rate is higher than the foreign interest rate. ..."
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This paper presents a sentimentbased explanation of the forward premium puzzle. Agents over or underestimate the growth rate of the economy. All else equal, when perceived domestic growth is higher than perceived foreign growth, the domestic interest rate is higher than the foreign interest rate. At the same time, an econometrician would expect an increase in the home currency value. Together, the model with investor misperception can account for the forward premium puzzle. In addition, it helps explain the low correlation of consumption growth differentials and exchange rate growth and the high stock market correlation across countries, despite a low correlation of fundamentals. Finally, this paper provides direct empirical evidence supporting the mechanism in the sentimentbased explanation.