the forecasting ability of correlations implied in foreign exchange options abstract this paper evaluates the forecasting accuracy of correlations derived from implied volatilities in dollar mark dollar yen and mark yen options from january 1989 to may 1995 as a forecast of realized correlation between the dollar mark and dollar yen implied correlation is compared against three alternative forecasts based on time series data historical correlation riskmetrics exponentially weighted moving average correlation and correlation estimated using a bivariate garch 1 1 model at the 1 month and 3 month forecast horizons we find that implied correlation outperforms often significantly these alternative forecasts in combinations implied correlation always incrementally improves the performance of other forecasts but not the converse in certain cases historically based forecasts contribute no incremental information to implied forecasts the superiority of the implied correlation forecast holds even when forecast errors are weighted by realized variances reflecting correlation s contribution to the dollar variance of a multicurrency portfolio

a comparison of alternative covariance matrices for models with over lapping observations abstract this paper investigates the relative performance of alternative covariance matrices for models with over lapping observations commonly used in the finance literature the alternative covariance matrices used are those of hansen 1982 newey and west 1987 bartlett and quadratic spectral qs weights and andrews and monahan 1992 qs weights all matrices produce standard errors which are too small yielding empirical size probabilities above their corresponding theoretical values even in large samples empirical examples such as testing efficiency in the foreign exchange market and mean reversion in stock prices show that the choice of covariance matrix can affect the outcome of a hypothesis test

stock returns implied volatility innovations and the asymmetric volatility phenomenon we study the dynamic relation between daily stock retums and daily innovations in optionderived implied volatilities by simultaneously analyzing innovations in index and firmlevel implied volatilities we distinguish between innovations in systematic and idiosyncratic volatility in an effort to better understand the asymmetric volatility phenomenon our results indicate that the relation between stock retums and innovations in systematic volatility idiosyncratic volatility is substantially negative near zero these results suggest that asymmetric volatility is primarily attributed to systematic market wide factors rather than aggregated firm level effects we also present evidence that supports our assumption that innovations in implied volatility are good proxies for innovations in expected stocic volatility

option pricing when the variance changes randomly theory estimation and an application in this paper we examine the pricing of european call options on stocks that have vari ance rates that change randomly we study continuous time diffusion processes for the stock return and the standard deviation parameter and we find that one must use the stock and two options to form a riskless hedge the riskless hedge does not lead to a unique option pricing function because the random standard deviation is not a traded security one must appeal to an equilibrium asset pricing model to derive a unique option pricing function in general the option price depends on the risk premium associated with the random standard deviation we find that the problem can be simplified by assuming that volatility risk can be diversified away and that changes in volatility are uncorrelated with the stock return the resulting solution is an integral ofthe black scholes formula and the distribution function for the variance of the stock price we show that accurate option prices can be computed via monte carlo simulations and we apply the model to a set of actual prices

ambiguous volatility and asset pricing in continuous time we formulate a model of utility for a continuous time framework that captures aversion to ambiguity about both volatility and drift corresponding extensions of some basic results in asset pricing theory are presented first we derive arbitrage free pricing rules based on hedging arguments because ambiguous volatility implies market incompleteness hedging arguments determine prices only up to intervals in order to obtain sharper predictions we apply the model of utility to a representative agent endowment economy and study equilibrium asset returns a version of the consumption capital asset pricing model is derived and the effects of ambiguous volatility are described the author 2013 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oup com oxford university press

the importance of the volatility risk premium for volatility forecasting in this paper we study the role of the volatility risk premium for the forecasting performance of implied volatility we introduce a non parametric and parsimonious approach to adjust the model free implied volatility for the volatility risk premium and implement this methodology using more than 20 years of options and futures data on three major energy markets using regression models and statistical loss functions we find compelling evidence to suggest that the risk premium adjusted implied volatility significantly outperforms other models including its unadjusted counterpart our main finding holds for different choices of volatility estimators and competing time series models underlying the robustness of our results

the pricing of options on assets with stochastic volatilities one option pricing problem that has hitherto been unsolved is the pricing of a european call on an asset that has a stochastic volatility this paper examines this problem the option price is determined in series form for the case in which the stochastic volatility is independent of the stock price numerical solutions are also produced for the case in which the volatility is correlated with the stock price it is found that the black scholes price frequently overprices options and that the degree of overpricing increases with the time to maturity one option pricing problem that has hitherto remained unsolved is the pricing of a european call on a stock that has a stochastic volatility from the work of merton 12 garman 6 and cox ingersoll and ross 3 the differential equation that the option must satisfy is known the solution of this differential equation is independent of risk preferences if a the volatility is a traded asset or b the volatility is uncorrelated with aggregate consumption if either of these conditions holds the risk neutral valuation arguments of cox and ross 4 can be used in a straightfoward way this paper produces a solution in series form for the situation in which the stock price is instantaneously uncorrelated with the volatility we do not assume that the volatility is a traded asset also a constant correlation between the instantaneous rate of change of the volatility and the rate of change of aggregate consumption can be accommodated the option price is lower than the blackscholes b s 1 price when the option is close to being at the money and higher when it is deep in or deep out of the money the exercise prices for which overpricing by b s takes place are within about ten percent of the security price this is the range of exercise prices over which most option trading takes place so we may in general expect the b s price to overprice options this effect is exaggerated as the time to maturity increases one of the most surprising implications of this is that if the b s equation is used to determine the implied volatility of a near the money option the longer the time to maturity the lower the implied volatility numerical solutions for the case in which the volatility is correlated with the stock price are also examined the stochastic volatility problem has been examined by merton 13 geske 7 johnson 10 johnson and shanno 11 eisenberg 5 wiggins 16 and

the formation of networks with transfers among players we examine the formation of networks among a set of players whose payoffs depend on the structure of the network when players may bargain by promising or demanding transfer payments when forming links we vary three aspects of the game i whether players can only make transfers to and receive transfers from players to whom they are directly linked or whether they can also subsidize links that they are not directly involved in ii whether or not transfers relating to a given link can be made contingent on the full resulting network or only on the link itself and iii whether or not players can pay other players to refrain from forming links we characterize the networks that are supported under these variations and show how each of the above aspects either accounts for a specific type of externality or deals with the combinatorial nature of network payoffs

the information content of implied stochastic volatility from currency options this paper investigates the predictability of implied variances extracted frorn currency options under the assumption that the options market is informationally efficient and that options are priced according to the models of black scholes 1973 hull white 1987 and heston 1993 implied variances are estimated from transaction prices of currency options traded on the philadelphia stock exchange phlx if implied variances are efficient variance forecasts from time series models should have no predictive power for subsequently realized market variances the empirical evidence on testing the implied volatility hypothesis is mixed latane and rendleman 1976 and chiras and manaster 1978 find evidence favourable to the hypothesis the weighted implied standard deviation explains more of the cross sectional variation in the future standard deviations of individual security returns than do historical volatilities day and lewis 1992 find that the implied volatilities from the s p 100 index options contain incremental information for the garch models canina and figlewski 1993 find evidence against the hypothesis the implied volatilities from s p 100 index options have less predictive power for subsequently realized volatility than simple historical volatilities lamoureux and lastrapes 1993 make the first attempt to introduce the stochastic volatility option model into the study of implied volatility their tests on individual stock options reject the orthogonality restriction that the forecast from time series models should not have predictive power in addition to implied volatility these findings based on stock index and individual stock options are inconsistent with the hypothesis that implied volatility is the optimal predictor of future volatility this contradiction motivates the present paper which explores the performance of implied volatility in the foreign exchange market the paper seeks to extend existing research by a reducing measurement errors b adopting stochastic volatility option pricing models and c improving the techniques of statistical inference

the term structure of volatility implied by foreign exchange options this paper illustrates regression and kalman filtering methods for estimating the time varying term structure of volatility expectations revealed by options prices short and long term expectations are estimated for four currencies using daily phlx options prices from 1985 to 1989 throughout this period there were important differences between shortand long term expectations the slope of the term structure changed frequently and there were significant variations in long term volatility expectations the expectation estimates can be used to value otc options to improve hedging strategies and to test the hypothesis that the options market overreacts

the volatility risk premium embedded in currency options this study employs a non parametric approach to investigate the volatility risk premium in the over the counter currency option market using a large database of daily delta neutral straddle quotes in four major currencies the british pound the euro the japanese yen and the swiss franc we find that volatility risk is priced in all four currencies across different option maturities we find that the volatility risk premium is negative with the premium decreasing in maturity finally we also find evidence that jump risk may be priced in the currency option market

bargaining foundations of shapley value1 a transferable utility economy in which each agent holds a resource which can be used in combination with the resources of other agents to generate value according to the characteristic function v is studied using a dynamic model of bargaining the main theorem establishes that the payoffs associated with efficient equilibria converge to the agents shapley values as the time between periods of the dynamic game goes to zero in addition it is demonstrated that an efficient equilibrium exists and is unique when an additivity condition is satisfied to demonstrate the sensitivity of the solution to the institutional detail we modify the model to allow for partnerships and show that the shapley value is no longer achieved

asymmetric information and options in an extension of the kyle 1985 model of continuous insider trading it is shown that asymmetric information can make it impossible to price options by arbitrage even when an option would appear to be redundant its introduction into the market can cause the volatility of the underlying asset to become stochastic this eliminates the potential for dynamically replicating the option the change in the price process of the asset reflects a change in the information transmitted by volume and prices when the option is traded article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

the informational content of implied volatility implied volatility is widely believed to be informationally superior to historical volatility because it is the markets forecast of future volatility but for s p 100 index options the most actively traded contract in the united states we find implied volatility in aggregate and across subsamples separated by maturity and strike price implied volatility has virtually no correlation with future volatility and it does not incorporate the information contained in recent observed volatility article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

the risk premium that never was a fair value explanation of the volatility spread abstract we present a new framework to investigate the profitability of trading the volatility spread the upward bias on implied volatility as an estimator of future realized volatility the scheme incorporates the first four option implied moments in a growth optimal payoff that is statically replicated using a portfolio of options removing the upward bias on implied volatility worsens the likelihood score of risk neutral densities obtained from s p 500 index options when they are used as forecasts of the underlying index return distribution it also results in negative expected capital growth when they are used in a volatility arbitrage scheme our empirical finding is that the upward bias on implied volatility does not represent a long term return premium rather it is required to mitigate the large losses associated with tail events when trading volatility in options markets

forming coalitions and the shapley ntu value a simple protocol for coalition formation is presented first an order of the players is randomly chosen then a coalition grows by sequentially incorporating new members in this order the protocol is studied in the context of non transferable utility ntu games in characteristic function form if weighted utility transfers are feasible when everybody cooperates then the expected subgame perfect equilibrium payoff allocation anticipated before any implemented game is the shapley ntu value

forecasting volatility of the u s oil market abstract we examine the information content of the cboe crude oil volatility index ovx when forecasting realized volatility in the wti futures market additionally we study whether other market variables such as volume open interest daily returns bid ask spread and the slope of the futures curve contain predictive power beyond what is embedded in the implied volatility in out of sample forecasting we find that econometric models based on realized volatility can be improved by including implied volatility and other variables our results show that including implied volatility significantly improves daily and weekly volatility forecasts however including other market variables significantly improves daily weekly and monthly volatility forecasts

conditional heteroscedasticity in time series of stock returns evidence and forecasts this article presents new evidence about the time series behavior of stock prices daily return series exhibit significant levels of second order dependence and they cannot be modeled as linear white noise processes a reasonable return generating process is empirically shown to be a first order autoregressive process with conditionally heteroskedastic innovations in particular generalized autoregressive conditional heteroskedastic garch 1 1 processes fit to data very satisfactorily various out of sample forecasts of monthly return variances are generated and compared statistically forecasts based on the garch model are found to be superior copyright 1989 by the university of chicago

the predictive power of implied volatility evidence from 35 futures markets abstract using data from 35 futures options markets from eight separate exchanges we test how well the implied volatilities ivs embedded in option prices predict subsequently realized volatility rv in the underlying futures we find that for this broad array of futures options iv performs well in a relative sense for a large majority of the commodities studied the implieds outperform historical volatility hv as a predictor of the subsequently rv in the underlying futures prices over the remaining life of the option indeed in most markets examined regardless of whether it is modeled as a simple moving average or in a garch framework hv contains no economically significant predictive information beyond what is already incorporated in iv these findings add to previous research that has focused on currency and crude oil futures by extending the analysis into a very broad array of contracts and exchanges our results are consistent with the hypothesis that futures options markets in general with their minimal trading frictions are efficient

allocating value among farsighted players in network formation we study the stability of networks when players are farsighted and allocations are determined endogenously the set of strongly efficient networks is the unique von neumann morgenstern farsightedly stable set with bargaining if the value function is anonymous component additive and top convex and the allocation rule is anonymous and component efficient moreover the componentwise egalitarian allocation rule emerges endogenously

the term structure of implied forward volatility recovery and informational content in the corn options market using a flexible method we develop the term structure of volatility implied by corn futures options with differing maturities and evaluate its ability to predict subsequent realized price volatility the implied forward volatilities anticipate realized volatility well for the nearby interval the implied forward volatilities provide unbiased forecasts and are superior to forecasts based on historical volatilities for more distant intervals early year options predict the direction and magnitude of future volatility changes about as well as a three year moving average and better than a naive forecast however later year options display less forecast power in part due to reduced trading activity

optimizing bounds on security prices in incomplete markets does stochastic volatility specification matter we extend and generalize some results on bounding security prices under two stochastic volatility models that provide closed form expressions for option prices in detail we compute analytical expressions for benchmark and standard good deal bounds for both models our findings show that our benchmark results generate much tighter bounds a deep analysis of the properties of option prices and bounds involving a sensitivity analysis and analytical derivation of greeks for both option prices and bounds is also presented these results provide strong practical applications taking into account the relevance of pricing and hedging strategies for traders financial institutions and risk managers

forming efficient networks abstract we suggest a simple sequential mechanism whose subgame perfect equilibria give rise to efficient networks moreover the payoffs received by the agents coincide with their shapley value in an appropriately defined cooperative game

a one stage model of link formation and payoff division abstract in this paper we introduce a strategic form model in which cooperation structures and divisions of the payoffs are determined simultaneously we analyze the cooperation structures and payoff divisions that result according to nash equilibria strong nash equilibria and coalition proof nash equilibria we find that no cycle will be formed if a player claims a positive amount for the formation of one of its links and that a player does not necessarily profit from a central position in a cooperation structure journal of economic literature classification numbers c71 c72

stock price distributions with stochastic volatility an analytic approach we study the stock price distributions that arise when prices follow a diffusion process with a stochastically varying volatility parameter we use analytic techniques to derive an explicit closed form solution for the case where volatility is driven by an arithmetic ornstein ublenbeck or ar1 process we then apply our results to two related problems in the finance literature 1 options pricing in a world of stochastic volatility and 2 the relationship between stochastic volatility and the nature of fat tailes in stock price distributions article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

does implied volatility provide any information beyond that captured in model based volatility forecasts this paper contributes to our understanding of the informational content of implied volatility here we examine whether the s p 500 implied volatility index vix contains any information relevant to future volatility beyond that available from model based volatility forecasts it is argued that this approach differs from the traditional forecast encompassing approach used in earlier studies the findings indicate that the vix index does not contain any such additional information relevant for forecasting volatility

forecasting fed cattle feeder cattle and corn cash price volatility the accuracy of time series implied volatility and composite approaches econonlists and others need estimates of future cash price volatility to use in risk management evaluation and education programs this paper evaluates the perfonnance of 211ternntive volatility forecasts for fed cattle feeder cattle and corn cash price returns forecasts include time series e g garch implied volatility from options on futures contract and composite specifications the overriding finding from this research consistent wiih the existing volatility forecasting literature is that no single method of volatility for ecasting provides superior accuracy across alternative data sets and horiyons however evidence is provided sugpe tinp that risk managers and extension educators use composite methods when both time series ant1 implied volatilities are available

a note on network formation with decay abstract this paper studies an endogenous network formation with decay we introduce a strategic form game based on a simple bilateral cost allocation rule we show that a strong nash equilibrium of this game always exists and necessarily achieves efficient networks

the risk premium of volatility implicit in currency options this article provides an empirical investigation of the risk neutral variance process and the market price of variance risk implied in the foreign currency options market there are three principal contributions first the parameters of heston s mean reverting square root stochastic volatility model are estimated using dollar mark option prices from 1987 to 1992 second it is shown that these implied parameters can be combined with historical moments of the dollar mark exchange rate to deduce an estimate of the market price of variance risk these estimates are found to be nonzero time varying and of sufficient magnitude to imply that the compensation for variance risk is a significant component of the risk premia in the currency market finally the out of sample test suggests that the historical variance and the hull and white implied variance contain no more information than that imbedded in the heston implied variance

realizing fair outcomes in minimum cost spanning tree problems through non cooperative mechanisms abstract in the context of minimum cost spanning tree problems we present a bargaining mechanism for connecting all agents to the source and dividing the cost among them the basic idea is very simple we ask each agent the part of the cost he is willing to pay for an arc to be constructed we prove that there exists a unique payoff allocation associated with the subgame perfect nash equilibria of this bargaining mechanism moreover this payoff allocation coincides with the rule defined in bergantinos and vidal puga bergantinos g vidal puga j j 2007a a fair rule in minimum cost spanning tree problems journal of economic theory 137 326 352

forecasting stock return variance toward an understanding of stochastic implied volatilities we examine the behavior of measured variances from the options market and the underlying stock market under the joint hypotheses that markets are informationally efficient and that option prices are explained by a particular asset pricing model forecasts from time series models of the stockreturn process should not have predictive content given the market forecast as embodied in option prices both in sample and out of sample tests suggest that this hypothesis can be rejected using simulations we show that biases inherent in the procedure we use to imply variances cannot explain this result thus we provide evidence inconsistent with the orthogonality restrictions of option pricing models that assume that variance risk is unpriced these results also have implicationsfor optimal variance forecast rules

overreactions in the options market this paper examines the term structure of options implied volatilities using data on s p 100 index options because implied volatility is strongly mean reverting the implied volatility on a longer maturity option should move by less than one percent in response to a one percent move in the implied volatility of a shorter maturity option empirically this elasticity turns out to be larger than suggested by rational expectations theory long maturity options tend to overreact to changes in the implied volatility of short maturity options are investors rational do they behave like bayesian statisticians when it comes to incorporating new information into asset prices proponents of the efficient markets hypothesis would answer this question in the affirmative many others however believe that bayesian rationality is a poor description of investor behavior and that as a consequence asset prices tend to be informationally inefficient one way in which inefficiencies might arise is through the overreactions of traders to the arrival of new information 1 this possibility is raised by experimental and survey findings which indicate that people have a systematic tendency to overemphasize recent data at the expense of other information when making projections 2 the objective of this paper is to search for evidence of such overreactive behavior in a semingly peculiar place the options market options may appear to be unlikely candidates for overreaction because unlike primary securities their prices are closely tied down by arbitrage considerations as black and scholes 1973 demonstrate if stock price volatility is known options prices are completely determined any deviation from the prescribed value implies a riskless profit opportunity however given that volatility is in fact unknown and changing options do retain something of an independent nature not wholly redundant with their underlying stocks options can be thought of as reflecting a speculative market in volatility the implied volatility on a given option obtained by inverting a

garch vs stochastic volatility option pricing and risk management this paper examines the out of sample performance of two common extensions of the black scholes framework namely a garch and a stochastic volatility option pricing model the models are calibrated to intraday ftse 100 option prices we apply two sets of performance criteria namely out of sample valuation errors and value at risk oriented measures when we analyze the fit to observed prices garch clearly dominates both stochastic volatility and the benchmark black scholes model however the predictions of the market risk from hypothetical derivative positions show sizable errors the fit to the realized profits and losses is poor and there are no notable differences between the models overall we therefore observe that the more complex option pricing models can improve on the black scholes methodology only for the purpose of pricing but not for the value at risk forecasts author s abstract

a conditional extreme value volatility estimator based on high frequency returns abstract this paper introduces a conditional extreme value volatility estimator evt based on high frequency returns the relative performance of the evt is compared with the discrete time garch and implied volatility models for 1 day and 20 day ahead forecasts of realized volatility this is also a first attempt towards detecting any time series variation in extreme value distributions using high frequency intraday data the information content of evt is examined in the context of forecasting sp 2 vix generally yields a less accurate characterization of realized volatility than evt and garch models these results have implications for financial risk management and are thus relevant to both regulators and practitioners

the information content of implied volatilities and model free volatility expectations evidence from options written on individual stocks abstract we measure the volatility information content of stock options for individual firms using option prices for 149 us firms and the s p 100 index we use arch and regression models to compare volatility forecasts defined by historical stock returns at the money implied volatilities and model free volatility expectations for every firm for 1 day ahead estimation a historical arch model outperforms both of the volatility estimates extracted from option prices for 36 of the firms but the option forecasts are nearly always more informative for those firms that have the more actively traded options when the prediction horizon extends until the expiry date of the options the option forecasts are more informative than the historical volatility for 85 of the firms however at the money implied volatilities generally outperform the model free volatility expectations

predicting volatility in the foreign exchange market measures of volatility implied in option prices are widely believed to be the best available volatility forecasts in this article we examine the information content and predictive power of implied standard deviations isds derived from chicago mercantile exchange options on foreign currency futures the article finds that statistical time series models even when given the advantage of ex post parameter estimates are outperformed by isds isds however also appear to be biased volatility forecasts using simulations to investigate the robustness of these results the article finds that measurement errors and statistical problems can substantially distort inferences even accounting for these however isds appear to be too variable relative to future volatility it is widely believed that the volatility implied in option prices is the market s best estimate of future volatility after all if it were not one could devise a trading strategy that could generate profits by identifying mispriced options the purpose of this article is to investigate the information content and predictive power of volatility implied in options on foreign currencies the paper focuses on options on currency futures traded on the chicago mercantile exchange cme because of the depth and liquidity of cme futures and options traded side by side in the same market implied standard deviations isds allow for clean tests of the predictive power of implied volatilities early studies of the information content of isds have generally found that these contain substantial information for future volatility latane and rendleman 1976 chiras and manaster 1978 and beckers 1981 for example regress future volatility on the weighted implied volatility across a broad sample of chicago board options exchange cboe stocks and find that options contain volatility forecasts that are more accurate than historical measures 1 these studies performed shortly after the 1973 beginning of the cboe option market could only use a relatively short time span and therefore focused on cross sections rather than time series predictions

statistical inference for random variance option pricing this article deals with the estimation of continuous time stochastic volatility models of option pricing we argue that option prices are much more informative about the parameters than are asset prices this is confirmed in a monte carlo experiment that compares two very simple strategies based on the different information sets both approaches are based on indirect inference and avoid any discretization bias by simulating the continuous time model we assume an ornstein uhlenbeck process for the log of the volatility a zero volatility risk premium and no leverage effect we do not pursue asymptotic efficiency or specification issues rather we stick to a framework with no overidentifying restrictions and show that given our option pricing model estimation based on option prices is much more precise in samples of typical size without increasing the computational burden

an options based analysis of emerging market exchange rate expectations brazil s real plan 1994 1999 abstract this paper uses currency option data to investigate market expectations on the brazilian real u s dollar exchange rate from october 1994 through march 1999 we derive implied probability density functions pdf for expected future exchange rates and thus measures of the credibility of the crawling peg and target zone regimes governing the exchange rate target zone credibility was poor prior to february 1996 improved afterwards through september 1997 and later started to worsen again the market anticipated periodic band adjustments and estimated distributions are very sensitive to political and economic news affecting the credibility of the regime

option pricing when the variance is changing the monte carlo method is used to solve for the price of a call when the variance is changing stochastically

economic effects by merger and acquisition types in the renewable energy sector an event study approach abstract this study classifies the types of mergers and acquisitions m a carried out in the renewable energy industry and explores their effects on enterprise value both the generalized autoregressive conditional heteroskedasticity and the ordinary least squares methodologies are used in an event study in order to improve the reliability of the presented analysis in order to understand how m a type affects enterprise value depending on the inter relationship between the acquirer and target business m a cases are divided into four groups homogeneous heterogeneous renewable heterogeneous energy and heterogeneous other from this analysis four implications can be drawn first homogeneous m a shows the biggest effect on enterprise value indicating that operating synergy and increasing market power are important factors when renewable energy firms undertake m a second m a with other industries of which financing companies take part in most show the second largest effect on enterprise value meaning that renewable energy is considered to have potential as an investment product further in the analysis of the wind power industry the result that heterogeneous other m a shows an even greater effect suggests that wind power is deemed to have a high potential for growth as an industry for investment lastly renewable energy m a in existing energy industries have negative effects on enterprise value indicating that strict regulations on the use of clean energy such as renewable energy result in energy companies incurring considerable costs

a utility based comparison of some models of exchange rate volatility abstract when estimates of variances are used to make asset allocation decisions underestimates of population variances lead to lower expected utility than equivalent overestimates a utility based criterion is asymmetric unlike standard criteria such as mean squared error to illustrate how to estimate a utility based criterion we use five bilateral weekly dollar exchange rates 1973 1989 and the corresponding pair of eurodeposit rates of homoskedastic garch autoregressive and non parametric models for the conditional variance of each exchange rate garch models tend to produce the highest utility on average a mean squared error criterion also favors garch but not as sharply

option pricing of earnings announcement risks this paper uses option prices to learn about the equity price uncertainty surrounding information released on earnings announcement dates to do this we introduce reduced form models and estimators to separate price uncertainty regarding earnings announcements from normal day to day volatility empirically we find strong support for the importance of earnings announcements we find that the anticipated price uncertainty is quantitatively large varies across time and is informative about the future return volatility finally we quantify the impact of earnings announcements on formal option pricing models

valuation of american call options on dividend paying stocks empirical tests abstract this paper examines the pricing performance of the valuation equation for american call options on stocks with known dividends and compares it with two suggested approximation methods the approximation obtained by substituting the stock price net of the present value of the escrowed dividends into the black scholes model is shown to induce spurious correlation between prediction error and 1 the standard deviation of stock return 2 the degree to which the option is in the money or out of the money 3 the probability of early exercise 4 the time to expiration of the option and 5 the dividend yield of the stock a new method of examining option market efficiency is developed and tested

the predictive power of the implied volatility of options traded otc and on exchanges abstract this paper investigates the efficiency of stock index options traded over the counter otc and on the exchanges in hong kong and japan our findings suggest that implied volatility is superior to either historical volatility or a garch type volatility forecast in predicting future volatility in both the otc and exchange markets this paper is also one of the first to compare the predictive power of the implied volatility of stock index options traded otc to that of exchange traded stock index options our evidence suggests that the otc market is more efficient than the exchanges in japan but that the opposite is true in hong kong

implied exchange rate distributions evidence from otc option markets abstract this paper uses a rich new dataset of option prices on the dollar mark dollar yen and key ems cross rates to extract the entire risk neutral probability density function pdf over horizons of 1 and 3 months we compare three alternative smoothing methods cubic splines an implied binomial tree trimmed and untrimmed and a mixture of lognormals for transforming option data into the pdf despite their methodological differences the three approaches lead to a similar pdf clearly distinct from the lognormal benchmark and typically characterized by skewness and leptokurtosis we then document a striking positive correlation between skewness in these pdfs and the spot rate the stronger a currency the more expectations are skewed towards a further appreciation of that currency we interpret this finding as a rejection that innovations in these exchange rates are independent of the level or characteristic of a credible target zone explicit or implicit instead this positive correlation is consistent with target zones with endogenous realignment risk we discuss two interpretations of our results on skewness when a currency is stronger the actual probability of further large appreciation is higher or because of risk such states are valued more highly

conditional volatility and the informational efficiency of the phlx currency options market abstract the relative performance of implied and historical volatility predictors is compared for four exchange rates from 1985 to 1991 for three currencies arch models estimated up to 1989 show that phlx implied volatilities provide specifications for daily conditional variances which can not be significantly improved by using past returns this result is consistent with the informational efficiency of the philadelphia currency options market out of sample forecasts of the average volatility over four week periods are evaluated for 1990 and 1991 once more the implied predictors are superior to historical predictors

a strategic model of social and economic networks we study the stability and efficiency of social and economic networks when self interested individuals can form or sever links first for two stylized models we characterize the stable and efficient networks there does not always exist a stable network that is efficient next we show that this tension persists generally to assure that there exists a stable network that is efficient one is forced to allocate resources to nodes that are not responsible for any of the production we characterize one such allocation rule the equal split rule and another rule that arises naturally from bargaining of the players

option values under stochastic volatility theory and empirical estimates abstract this paper numerically solves the call option valuation problem given a fairly general continuous stochastic process for return volatility statistical estimators for volatility process parameters are derived and parameter estimates are calculated for several individual stocks and indices the resulting estimated option values do not differ dramatically from black scholes values in most cases although there is some evidence that for longer maturity index options black scholes overvalues out of the money calls in relation to in the money calls

subscription mechanisms for network formation we analyze a model of network formation where the costs of forming links are publicly known but an individual s benefits are not known to the social planner the objective is to design a mechanism which not only ensures that an efficient network always forms in equilibrium but also ensures that the resulting net payoffs to the agents are equitable we propose two mechanisms towards this end in the first agents announce sequentially the set of players with whom they wish to form links and a cost contribution we show that all subgame perfect equilibria of this game result in the formation of an efficient network but the resulting net payoffs are asymmetric the second mechanism corrects this asymmetry through a two stage variant of the first mechanism we also discuss an extension of the basic model to cover the case of directed graphs and give conditions under which the proposed mechanisms are immune to deviations by coalitions

the creation and resolution of market uncertainty the impact of information releases on implied volatility we model and examine the impact of information releases on market uncertainty as mea sured by the implied standard deviation isd from option markets distinguishing between scheduled and unscheduled announcements we hypothesize that since the timing although not the content of scheduled announcements is known a priori the pre release isd will impound the anticipated impact of important releases on price volatility and that the isd will normally decline post release as this uncertainty is resolved conversely we hypothesize that the unexpected high volatility caused by major unscheduled releases will cause market participants to adjust upward their estimates of likely volatility over the remaining life of the option resulting in an increase in the isd our evidence supports both hypotheses the isds that we consider are from the t bond eurodollar and deutschemark options markets we examine scheduled macroeconomic news releases such as the employment report and the ppi we also find that the observed tendency for the isd to fall on fridays and rise on mondays is due to the weekday pattern of scheduled news releases

option pricing where the underlying assets follow a gram charlier density of arbitrary order abstract if a probability distribution is sufficiently close to a normal distribution its density can be approximated by a gram charlier series a expansion in option pricing this has been used to fit risk neutral asset price distributions to the implied volatility smile ensuring an arbitrage free interpolation of implied volatilities across exercise prices however the existing literature is restricted to truncating the series expansion after the fourth moment this paper presents an option pricing formula in terms of the full untruncated series and discusses a fitting algorithm which ensures that a series truncated at a moment of arbitrary order represents a valid probability density while it is well known that valid densities resulting from truncated gram charlier series a expansions do not always have sufficient flexibility to fit all market observed option prices perfectly this paper demonstrates that option pricing in a model based on these densities is as tractable as the far less flexible original model of black and scholes 1973 allowing non trivial higher moments such as skewness excess kurtosis and so on to be incorporated into the pricing of exotic options generalising the gram charlier series a approach to the multiperiod multivariate case a model calibrated to standard option prices is developed in which a large class of exotic payoffs can be priced in closed form furthermore this approach when applied to a foreign exchange option market involving several currencies can be used to ensure that the volatility smiles for options on the cross exchange rate are constructed in a consistent arbitrage free manner

using implied volatility on options to measure the relation between asset returns and variability abstract prior research has documented that volatility in financial asset markets is most directly related to trading rather than calendar days and that there is an inverse asymmetric relation between volatility and returns in both stocks and long term bonds we examine these relations in 37 futures options markets representing a wide variety of asset types using futures prices and implied volatilities from this extensive array of markets we confirm that in all of them save one market volatility is more directly related to trading days however the nature of the association between implied volatility and underlying asset returns varies greatly across asset categories and across exchanges thus we show that findings from equity markets apparently are not generalizable to other asset classes

invisible parameters in option prices this paper characterizes contingent claim formulas that are independent of parameters governing the probability distribution of asset returns while these parameters may affect stock bond and option values they are invisible because they do not appear in the optiqn formulas for example the black scholes 1973 formula is independent of the mean of the stock return this paper presents a new formula based on the log negative binomial distribution in analogy with cox ross and rubinstein s 1979 log binomial formula the log negative binomial option price does not depend on the jump probability this paper also presents a new formula based on the log gamma distribution in this formula the option price does not depend on the scale of the stock return but does depend on the mean of the stock return this paper extends the log gamma formula to continuous time by defining a gamma process the gamma process is a jump process with independent increments that generalizes the wiener process unlike the poisson process the gamma process can instantaneously jump to a continuum of values hence it is fundamentally unhedgeable if the gamma process jumps upward then stock returns are positively skewed and if the gamma process jumps downward then stock returns are negatively skewed the gamma process has one more parameter than a wiener process this parameter controls the jump intensity and skewness of the process the skewness of the log gamma process generates strike biases in options in contrast to the results of diffusion models these biases increase for short maturity options thus the log gamma model produces a parsimonious option pricing formula that is consistent with empirical biases in the black scholes formula

a theory of gradual coalition formation we study noncooperative multilateral bargaining games based on underlying tu games in which coalitions can renegotiate their agreements we distinguish between models in which players continue to bargain after implementing agreements reversible actions and models in which players who implement agreements must leave the game irreversible actions we show that renegotiation always results in formation of the grand coalition if actions are reversible but that the process may otherwise end with smaller coalitions on the other hand we show that the grand coalition cannot form in one step if the core of the game is empty irrespective of the reversibility of actions agreements between players form the basis of much that game theory seeks to explain there are obviously many useful ways to categorize such agreements in multilateral negotiations that is with more than two participants it seems natural to distinguish between cases in which the coalition forms in one step and those in which the coalition grows to its eventual size by attracting new members thus recipients of marshall aid collectively agreed to american terms at the ceec in 1947 whereas a strict subset of these countries agreed to the schuman plan in 1950 with the other current members joining the eu over time similarly negotiations on climate change culminated in universal agreement at rio in 1992 whereas india and china only agreed to reduce cfc emissions in london in 1990 after other countries had signed up to the montreal protocol finally un security council resolution 242 urged that a multilateral conference be set up to establish a comprehensive settlement in the middle east whereas the process initiated by the oslo agreements and arguably camp david has consisted of a sequence of agreements between israel and its neighbours we will refer to cases in which the grand coalition forms in one step as involving immediate coalition formation or icf for short and cases in which a coalition grows as involving gradual coalition formation

a noncooperative coalitional bargaining game with random proposers abstract we extend the stahl rubinstein s alternating offer model ton person coalitional bargaining the key feature of the model is the random selection of proposers at every round no delay of agreement occurs in equilibrium for a super additive game in contrast to the fixed order model of chatterjeeet al rev econ stud 60 1993 463 477 when the discount factor of future payoffs is sufficiently high the agreement on the grand coalition is reached if and only if it has the largest value per capita among all coalitions moreover in the limit as the discount factor goes to one all players divide equally the value of the grand coalition regardless of who makes a proposal journal of economic literatureclassification numbers c72 c73 c78

forecasting stock market volatility and information content of implied volatility index abstractthis study investigates the incremental information content of implied volatility index relative to the garch family models in forecasting volatility of the three asia pacific stock markets

persistence in variance structural change and the garch model this article examines the persistence of the variance as measured by the generalized autoregressive conditional heteroskedasticity garch model in stock return data in particular we investigate the extent to which persistence in variance may be overstated because of the existence of and failure to take account of deterministic structural shifts in the model both an analysis of daily stock return data and a monte carlo simulation experiment confirm the hypothesis that garch measures of persistence in variance are sensitive to this type of model misspecification

the information frown in option prices in the s p 500 options market the information content of implied volatilities differs by strike in a frown pattern that is a rough mirror image of the implied volatilitysmile implied volatilities calculated from moderatelyhigh strike price options are both unbiased and efficient predictors of future volatility implied volatilities calculated from low and at the money strikes are biased and less efficient this bias cannot be explained bymarket imperfections but is consistent with the hedging pressure argument of bollen and whaley j finan 59 2004 711 and ederington and guan j derivat 10 2002 winter 9 we also find that a serious estimation bias results when the relations are estimated using panel data 2004 elsevier b v all rights reserved

forecasting volatility of futures market the s p 500 and ftse 100 futures using high frequency returns and implied volatility we show that historical volatility from high frequency returns outperforms implied volatility when standardized returns by historical volatility tends to be normally distributed for the ftse 100 futures we find that historical volatility using high frequency returns outperforms implied volatility in forecasting future volatility however we find that implied volatility outperforms historical volatility in forecasting future volatility for the s p 500 futures the results also indicate that historical volatility using high frequency returns could be an unbiased forecast for the ftse 100 futures 1 we thank christopher lowes for his excellent research assistance

home grown or imported initial conditions external anchors and the determinants of institutional reform in the transition economies in this article we examine the determinants of institutional change using a panel dataset comprising 25 transition economies a defining characteristic of our approach is that we treat institutional change as a multidimensional unobserved variable accounting for the fact that each of our indicators represents a noisy signal our results suggest that institutional change is significantly path dependent however policy can to some extent break this dependence through economic and political liberalisation at the start of the transition and with the help of an external anchor such as eu accession