a vector autoregressive model for electricity prices subject to long memory and regime switching abstract a regime dependent var model is suggested that allows long memory fractional integration in each of the observed regime states as well as the possibility of fractional cointegration the model is motivated by the dynamics of electricity prices where the transmission of power is subject to occasional congestion periods for a system of bilateral prices non congestion means that electricity prices are identical whereas congestion makes prices depart hence the joint price dynamics implies switching between a univariate price process under non congestion and a bivariate price process under congestion at the same time it is an empirical regularity that electricity prices tend to show a high degree of long memory and thus that prices may be fractionally cointegrated analysis of nord pool data shows that even though the prices are identical under non congestion the prices are not in general fractionally cointegrated in the congestion state hence in most cases price convergence is a property following from regime switching rather than a conventional error correction mechanism finally the suggested model is shown to deliver forecasts that are more precise compared to competing models

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

reading pibor futures options smiles the 1997 snap election abstract in this paper we compare various methods that extract a risk neutral density rnd out of pibor interest rate futures options and we investigate how traders react to a political event our benchmark model derives from a brace d gatarek m musiela mathematical finance 7 1997 127 155 we also consider a mixture of log normals as in w r melik c p thomas journal of financial and quantitative analysis 32 1997 91 116 an hermite expansion as in p abken d b madan s ramamurtie estimation of risk neutral and statistical densities by hermite polynomial approximation with an application to eurodollar futures options federal reserve bank of atlanta 1996 and a method based on maximum entropy according to p buchen m kelly journal of financial and quantitative analysis 31 1996 143 159 we take care of the early exercise feature and we show how to approximate rnds for a fixed time to maturity the various methods generate similar rnds a daily panel of options running from february 1997 to july 1997 reveals that operators expected the snap election a few days before the official announcement was made and that a substantial amount of political uncertainty subsisted even a month after the elections uncertainty evolved with polls forecasts of the future government

fitting semiparametric markov regime switching models to electricity spot prices abstract recently regime switching models have become the standard tool for modeling electricity prices these models capture the main properties of electricity spot prices well but estimation of the model parameters requires computer intensive methods moreover the distribution of the price spikes must be fully specified although the high volatility of the spikes makes it difficult to check such distributional assumptions consequently there are a number of competing proposals for the distribution in the spike regime as an alternative we propose a semiparametric markov regime switching model that leaves the distribution under the spike regime unspecified we show that the model parameters can be estimated by employing robust statistical techniques this presents an alternative to the existing estimation methods that are based on computer intensive numerical maximization of the likelihood function the model in combination with the estimation framework is easier to estimate needs less computation time and distributional assumptions to show its advantages we compare the proposed model with a well established markov regime switching model in a simulation study furthermore we apply the model to log prices for the australian electricity market the results are in accordance with the results from the simulation study indicating that the proposed model might be advantageous whenever the distribution of the spike process is not sufficiently known the results are thus encouraging and suggest the use of our approach when modeling electricity prices and pricing derivatives

normal mixture diffusion with uncertain volatility modelling short and long term smile effects this paper introduces a parameterization of the normal mixture diffusion nmd local volatility model that captures only a short term smile effect and then extends the model so that it also captures a long term smile effect we focus on the binomial nmd parameterization so called because it is based on simple and intuitive assumptions that imply the mixing law for the normal mixture log price density is binomial with more than two possible states for volatility the general parameterization is related to the multinomial mixing law in this parsimonious class of complete market models option pricing and hedging is straightforward since model prices and deltas are simple weighted averages of black scholes prices and deltas but they only capture a short term smile effect where leptokurtosis in the log price density decreases with term in accordance with the stylised facts of econometric analysis on ex post returns of different frequencies and the central limit theorem however the last part of the paper shows that longer term smile effects that arise from uncertainty in the local volatility surface can be modeled by a natural extension of the binomial nmd parameterization results are illustrated by calibrating the model to several euro us dollar currency option smile surfaces

generalized parameter functions for option pricing we extend the benchmark nonlinear deterministic volatility regression functions of dumas et al 1998 to provide a semi parametric method where an enhancement of the implied parameter values is used in the parametric option pricing models besides volatility skewness and kurtosis of the asset return distribution can also be enhanced empirical results using closing prices of the s p 500 index call options in one day ahead out of sample pricing tests strongly support our method that compares favorably with a model that admits stochastic volatility and random jumps moreover it is found to be superior in various robustness tests our semi parametric approach is an effective remedy to the curse of dimensionality presented in nonparametric estimation and its main advantage is that it delivers theoretically consistent option prices and hedging parameters the economic significance of the approach is tested in terms of hedging where the evaluation and estimation loss functions are aligned

an empirical comparison of alternate regime switching models for electricity spot prices one of the most profound features of electricity spot prices are the price spikes markov regime switching mrs models seem to be a natural candidate for modeling this spiky behavior however in the studies published so far the goodness of fit of the proposed models has not been a major focus while most of the models were elegant their fit to empirical data has either been not examined thoroughly or the signs of a bad fit ignored with this paper we want to fill the gap we calibrate and test a range of mrs models in an attempt to find parsimonious specifications that not only address the main characteristics of electricity prices but are statistically sound as well we find that the most universal and robust structure is that of an independent spike 3 regime model with heteroscedastic diffusion type base regime dynamics and shifted spike regime distributions

mobility and redistribution the ability of individuals to move freely from one jurisdiction to another is generally seen as a constraint on the amount of redistribution that each jurisdiction within a system of governments can undertake in this paper we look at this proposition by developing a positive analysis of income redistribution by local governments in a federal system we ask how much redistribution occurs when only local governments can have tax transfer instruments individuals can move freely among jurisdictions and voters in each jurisdiction are fully aware of the migration effects of redistributive policies local redistribution is shown to induce sorting of the population with the poorest households located in the communities that provide the most redistribution while the threat of out migration affects the potential for redistribution our results suggest that significant local redistribution is nonetheless feasible numerical computations indicate that the proportion of residents who are renters is a major factor affecting the local choice of level of redistribution

electricity pool prices a case study in nonlinear time series modelling this paper considers modelling the behaviour of prices in the english and welsh wholesale electricity pool since the creation of this spot market in 1990 the process turns out to be nonlinear and a logistic smooth transition autoregressive model is fitted and shown to be superior to a linear alternative the behaviour of the estimated model is discussed and it is seen that nonlinearity is needed to describe the institutional characteristics and historical path of pool prices

wavelet based option pricing an empirical study abstract in this paper we scrutinize the empirical performance of a wavelet based option pricing model which leverages the powerful computational capability of wavelets in approximating risk neutral moment generating functions we focus on the forecasting and hedging performance of the model in comparison with that of popular alternative models including the stochastic volatility model with jumps the practitioner black scholes model and the neural network based model using daily index options written on the german dax 30 index from january 2009 to december 2012 our results suggest that the wavelet based model compares favorably with all other models except the neural network based one especially for long term options hence our novel wavelet based option pricing model provides an excellent nonparametric alternative for valuing option prices

capital structure and financial flexibility expectations of future shocks abstract we test one of the main predictions of the financial flexibility paradigm that expectations about future firm specific investment shocks affect the firm s leverage we extract the expectations of small and large future shocks from the market prices of equity options we find that leverage decreases when expectations for any one of the two types of future shocks increase and the relation is statistically significant even when we control for standard determinants of leverage and the firm s probability of default expectations for future shocks explain a greater fraction of leverage variation than most standard determinants of leverage do and they affect more the small and financially constrained firms our results are not subject to an endogeneity bias and they confirm deangelo et al 2011 model s predictions and the evidence that managers seek for financial flexibility

valuation of vix derivatives abstract we conduct an extensive empirical analysis of vix derivative valuation models before during and after the 2008 2009 financial crisis since the restrictive mean reversion and heteroskedasticity features of existing models yield large distortions during the crisis we propose generalisations with a time varying central tendency jumps and stochastic volatility analyse their pricing performance and implications for term structures of vix futures and volatility skews we find that a process for the log of the observed vix combining central tendency and stochastic volatility reliably prices vix derivatives we also uncover a significant risk premium that shifts the long run volatility level

regime jumps in electricity prices many countries are liberalizing their energy markets participants in these markets are exposed to market risk due to the characteristics of electricity price dynamics electricity prices are known to be mean reverting very volatile and subject to frequent spikes models that describe the dynamics of electricity prices should incorporate these characteristics in order to capture the price spikes many researchers have introduced stochastic jump processes but we argue and show that this specification might lead to potential problems with specifying the true amount of mean reversion within the process in this paper we propose a regime switching model that models price spikes separated from normal mean reverting prices

implied volatility surface predictability the case of commodity markets abstract recent literature seek to forecast implied volatility derived from equity index foreign exchange and interest rate options using latent factor and parametric frameworks motivated by increased public attention borne out of the financialization of futures markets in the early 2000s we investigate if these extant models can uncover predictable patterns in the implied volatility surfaces of the most actively traded commodity options between 2006 and 2016 adopting a rolling out of sample forecasting framework that addresses the common multiple comparisons problem we establish that for energy and precious metals options explicitly modeling the term structure of implied volatility using the nelson siegel factors produces the most accurate forecasts

vix option pricing and cboe vix term structure a new methodology for volatility derivatives valuation abstract this study integrates cboe vix term structure and vix futures to simplify vix option pricing in multifactor models exponential and hump volatility functions with one to three factor models of the vix evolution are used to examine their pricing for vix options across strikes and maturities the results show that using exponential volatility functions presents an effective choice as pricing models for vix calls whereas hump volatility functions provide efficient out of sample valuation for most vix puts in particular with deep in the money and deep out of the money pricing errors for calls can be further reduced with a two factor model

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

nonparametric tests of alternative option pricing models using all reported trades and quotes on the 30 most active cboe option classes from august 23 1976 through august 31 1978

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

statistical tests of contingent claims asset pricing models abstract a new methodology for statistically testing contingent claims asset pricing models based on asymptotic statistical theory is proposed it is introduced in the context of the black scholes option pricing model for which some illustrative estimation inference and simulation results are also presented the proposed methodology is then extended to arbitrary contingent claims by first considering the estimation problem for general ito processes and then deriving the asymptotic distribution of a general contingent claim which depends upon such ito processes

why is the market for long term care insurance so small abstract long term care represents one of the largest uninsured financial risks facing the elderly in the united states we present evidence of supply side market failures in the private long term care insurance market in particular the typical policy purchased exhibits premiums marked up substantially above expected benefits it also provides very limited coverage relative to the total expenditure risk however we present additional evidence suggesting that the existence of supply side market failures is unlikely by itself to be sufficient to explain the very small size of the private long term care insurance market in particular we find enormous gender differences in pricing that do not translate into differences in coverage and we show that more comprehensive policies are widely available if seldom purchased at similar loads to purchased policies this suggests that factors limiting demand for insurance are also likely to be important in this market our evidence also sheds light on the likely nature of these demand side factors

consistent modeling of s p 500 and vix derivatives abstract this study introduces a model that identifies relationships between stylized features on s p 500 vix and derivatives on vix the paper considers a specification with discontinuous correlated jumps in stock prices and stock price volatility with state dependent arrival intensity and examines how these factors impact vix option pricing and hedging the paper finds strong evidence for jumps in volatility and jumps in returns implicit in vix option data

underreaction overreaction and increasing misreaction to information in the options market this paper investigates options market reaction to changes in the instantaneous variance of the underlying asset there are three main findings first options market investors underreact to individual daily changes in instantaneous variance second these same investors overreact to periods of mostly increasing or mostly decreasing daily changes in instantaneous variance third they tend to underreact overreact to current daily changes in instantaneous variance that are preceded mostly by daily changes of the opposite same sign the third finding can reconcile the first two and is also consistent with well established cognitive biases

hedging derivative securities and incomplete markets an e arbitrage approach given a european derivative security with an arbitrary payoff function and a corresponding set of underlying securities on which the derivative security is based we solve the optimal replication problem find a self financing dynamic portfolio strategy involving only the underlying securities that most closely approximates the payoff function at maturity by applying stochastic dynamic programming to the minimization of a mean squared error loss function under markov state dynamics we derive recursive expressions for the optimal replication strategy that are readily implemented in practice the approximation error or e of the optimal replication strategy is also given recursively and may be used to quantify the degree of market incompleteness to investigate the practical significance of these e arbitrage strategies we consider several numerical examples including path dependent options and options on assets with stochastic volatility and jumps

parametric pricing of higher order moments in s p500 options a general parametric framework based on the generalized student t distribution is developed for pricing s p500 options higher order moments in stock returns as well as time varying volatility are priced an important computational advantage of the proposed framework over monte carlo based pricing methods is that options can be priced using one dimensional quadrature integration the empirical application is based on s p500 options traded on select days in april 1995 a total sample of over 100 000 observations a range of performance criteria are used to evaluate the proposed model as well as a number of alternative models the empirical results show that pricing higher order moments and time varying volatility yields improvements in the pricing of options as well as correcting the volatility skew associated with the black scholes model

financial statement comparability and expected crash risk this study examines the impact of financial statement comparability on ex ante crash risk using the comparability measures of de franco et al 2011 we find that expected crash risk decreases with financial statement comparability and this negative relation is more pronounced in an environment where managers are more prone to withhold bad news we also provide evidence that comparability can mitigate the asymmetric market reaction to bad versus good news disclosures our results suggest that financial statement comparability disinclines managers from bad news hoarding which reduces investors perceptions of a firm s future crash risk

reading the smile the message conveyed by methods which infer risk neutral densities abstract in this study we compare the quality and information content of risk neutral densities obtained by various methods we consider a non parametric method based on a mixture of log normal densities the semi parametric ones based on an hermite approximation or based on an edgeworth expansion the parametric approach of malz which assumes a jump diffusion for the underlying process and heston s approach assuming a stochastic volatility model we apply those models on ff dm exchange rate options for two dates models differ when important news hits the market here anticipated elections the non parametric model provides a good fit to options prices but is unable to provide as much information about market participants expectations than the jump diffusion model

electricity price forecasting using sale and purchase curves the x model abstract our paper aims to model and forecast the electricity price by taking a completely new perspective on the data it will be the first approach which is able to combine the insights of market structure models with extensive and modern econometric analysis instead of directly modeling the electricity price as it is usually done in time series or data mining approaches we model and utilize its true source the sale and purchase curves of the electricity exchange we will refer to this new model as x model as almost every deregulated electricity price is simply the result of the intersection of the electricity supply and demand curve at a certain auction therefore we show an approach to deal with a tremendous amount of auction data using a subtle data processing technique as well as dimension reduction and lasso based estimation methods we incorporate not only several known features such as seasonal behavior or the impact of other processes like renewable energy but also completely new elaborated stylized facts of the bidding structure our model is able to capture the non linear behavior of the electricity price which is especially useful for predicting huge price spikes using simulation methods we show how to derive prediction intervals for probabilistic forecasting we describe and show the proposed methods for the day ahead epex spot price of germany and austria

predicting price spikes in electricity markets using a regime switching model with time varying parameters this paper shows that a stochastic regime switching model can represent the volatile behavior of wholesale electricity prices associated with price spikes effectively the structure of the model is very flexible because the mean prices in the two regimes and the two transition probabilities are functions of the load and or the implicit reserve margin using price data from the single settlement market in pjm may 1999 to may 2000 the results show that the estimated switching probability from the low to the high regime predicts price spikes well if the reserve margin is measured accurately

a comparison of pricing and hedging performances of equity derivatives models abstractthis article investigates the pricing hedging conundrum i e the observation of a mismatch between derivatives models pricing and hedging performances that has so far been under emphasized as the literature tends to focus on increasingly complicated option pricing models without adequately addressing hedging performance hence we analyse the ability of the black scholes practitioner black scholes heston nandi and heston models to delta hedge a set of call options on the s p500 index and apple stock we extend earlier studies in that we consider the impact of asset dynamics apply a stringent payoff replication strategy look at the impact of moneyness at maturity and test for the robustness to the parameters calibration frequency and delta vega hedging the study shows that adding risk factors to a model as stochastic volatility should only be considered in light of the data dynamics even then however more complicated models generally fare poorly for hedging purposes hence a better

on the no arbitrage condition in option implied trees the aim of this paper is to discuss the no arbitrage condition in option implied trees based on forward induction and to propose a no arbitrage test that rules out the negative probabilities problem and hence enhances the pricing performance the no arbitrage condition takes into account two main features the position of the node in the tree and the relation between the dividend yield and the risk free rate the proposed methodology is tested in and out of sample with italian index options data and findings support a good pricing performance

predictable dynamics in implied volatility surfaces from otc currency options recent empirical studies report predictable dynamics in the volatility surfaces that are implied by observed index option prices such as those prescribed by general equilibrium models using an extensive data set from the over the counter options market we document similar predictability in the factors that capture the daily variation of surfaces implied by options on 25 different foreign exchange rates we proceed to demonstrate that simple vector autoregressive specifications for the factors can help produce accurate out of sample forecasts of the systematic component of the surface at short horizons profitable delta hedged positions can be set up based on these forecasts however profits disappear when typical transaction costs are taken into account and when trading rules on wide segments of the surface are sought

savings of the elderly and desired bequests cross section data often show that the wealth of the elderly increases with age even at advanced ages these and other results suggest that the life cycle hypothesis of consumption should be augmented to include a bequest motive for saving in this paper the author proposes a model of bequests and a test for a bequ est motive using panel data he finds that over a ten year period the elderly in the data set dissaved in contradiction to most cross section results the test offers no support for a bequest motive copyright 1987 by american economic association

the limitation of monotonicity property of option prices an empirical evidence many option pricing models are based on the assumption that the underlying asset price follows one dimensional diffusion process an alternative approach is to test the properties that should hold for all models based on a given stochastic process for the underlying asset following perignon 2006 we test the empirical validity of the monotonicity property for option prices by collecting all transaction data from 1 july 2006 to 31 december 2006 for option contracts traded on the taiwan futures exchange taifex we find that sampled intraday option prices violate the monotonicity property between 29 97 and 57 of the time and that call and put prices often increase or decrease together we also find evidence to show that the frequent violations of the monotonicity property are to a large extent attributable to microstructure effects and that they arise from rational trading tactics

model free hedge ratios and scale invariant models a price process is scale invariant if and only if the returns distribution is independent of the price measurement scale we show that most stochastic processes used for pricing options on financial assets have this property and that many models not previously recognised as scale invariant are indeed so we also prove that price hedge ratios for a wide class of contingent claims under a wide class of pricing models are model free in particular previous results on model free price hedge ratios of vanilla options based on scale invariant models are extended to any contingent claim with homogeneous pay off including complex path dependent options however model free hedge ratios only have the minimum variance property in scale invariant stochastic volatility models when price volatility correlation is zero in other stochastic volatility models and in scale invariant local volatility models model free hedge ratios are not minimum variance ratios and our empirical results demonstrate that they are less efficient than minimum variance hedge ratios

an empirical comparison of continuous time models of implied volatility indices abstract we explore the ability of alternative popular continuous time diffusion and jump diffusion processes to capture the dynamics of implied volatility indices over time the performance of the various models is assessed under both econometric and financial metrics to this end data are employed from major european and american implied volatility indices and the rapidly growing cboe volatility futures market we find that the addition of jumps is necessary to capture the evolution of implied volatility indices under both metrics mean reversion is of second order importance though the results are consistent across the various metrics markets and construction methodologies

estimation of parametric homogeneous stochastic volatility pricing formulae based on option data this article provides a procedure for the estimation of parametric homogeneous stochastic volatility sv pricing formulae based on option data our estimator has the advantage of being i based on option data ii easy to implement in practice iii with clear statistic properties and iv applicable under more general assumptions about pricing formulae and error terms

dollar jump fears 1984 1992 distributional abnormalities implicit in currency futures options abstract deutsche mark and yen futures options over 1984 1992 and 1986 1992 respectively are examined for deviations from the lognormal assumption underlying standard option pricing models two methods are used an atheoretic skewness premium and daily estimates of moments using a model for pricing american foreign currency futures options under systematic exchange rate jump risk substantial variation over time is found in all moments including implicit skewness and kurtosis the implicit abnormalities predict future abnormalities in log differenced dm futures prices but not yen the peso problem implications do not explain standard rejections of uncovered interest parity

the components of the return from hedging options against stocks in a previous paper galai 1977 i estimated the profits that could have been made by following a hedging strategy which consisted of a position in an option traded on the chicago board options exchange cboe and an offsetting position in a fraction of a share of the underlying stock the paper concluded that 1 the trading strategies based on the black scholes model black and scholes 1973 perform well in tests of the ex post hedge return 2 the market did not seem perfectly efficient to market makers the ex ante returns while usually statistically significant show a strong tendency to be positive p 195 in this article the profits from the hedging i strategies with options are further analyzed the returns are decomposed to a few components in order to achieve a better understanding and additional insight into their character two main factors will be shown to combine to give the hedge return the profits or losses from discrete ad

measuring systemic risk adjusted liquidity srl a model approach abstract little progress has been made so far in addressing in a comprehensive way the negative externalities caused by excessive maturity transformation and the implications for effective liquidity regulation of banks the srl model combines option pricing theory with market information and balance sheet data to generate probabilistic measure of systemic liquidity risk it enhances price based liquidity regulation by linking a bank s maturity mismatch impacting the stability of its funding with those characteristics of other banks subject to individual changes in risk profiles and common changes in market conditions impacting funding and market liquidity risk this approach can then be used i to quantify an individual institution s time varying contribution to expected losses from system wide liquidity shortfalls and ii to price insurance premia that provide incentives for banks to internalize the social cost of their individual funding decisions

how important is the term structure in implied volatility surface modeling evidence from foreign exchange options we claim that previously proposed parametric specifications that linearly approximate the term structure of the implied volatility surface ivs in option prices fail to capture important information regarding the expectations of market participants this paper proposes a parametric specification for describing the ivs that allows flexible modeling of the term structure through a nelson and siegel 1987 factorization recently proposed by diebold and li 2006 in the context of yield curve modeling the specification is tested on implied volatilities from the over the counter foreign exchange options market where contracts with long expiries are actively traded and thus the term structure dimension of the surface should be very important we first show that the proposed volatility specification can consistently and remarkably improve our ability to describe the surface on any given day we then establish the economic relevance of the incremental information captured by our proposed specification by showing that it can produce more accurate forecasts of implied volatility that can support long term profitable trading strategies in the absence of transaction costs

recovering probability distributions from option prices this article derives underlying asset risk neutral probability distributions of european options on the s p 500 index nonparametric methods are used to choose probabilities that minimize an objective function subject to requiring that the probabilities are consistent with observed option and underlying asset prices alternative optimization specifications produce approximately the same implied distributions a new and fast optimization technique for estimating probability distributions based on maximizing the smoothness of the resulting distribution is proposed since the crash the risk neutral probability of a three four standard deviation decline in the index about 36 percent 46 percent over a year is about 10 100 times more likely than under the assumption of lognormality recently the increasing popularity of derivatives and some highly publicized failures to control risk have led to increased efforts to find reasonable methods to measure the sensitivity of large institutional derivatives portfolios to extreme events merely because such events are rare is not sufficient to ignore them since on the few occasions when they do occur significant amounts of money can change hands potentially wiping out profits accumulated over long prior periods a key assumption behind methods of estimation is the joint probability distribution of constituent underlying asset returns this has long been a concern of financial economists since probability assumptions are critical to much of their research during the last quarter century heretofore probability distributions of stock market returns have typically been estimated from historical time series unfortunately common hypotheses may not capture the probability of extreme events and the events of interest are rare or may not be present in the historical record even though they are clearly possible

the influence of temperature on spike probability in day ahead power prices it is well known that day ahead prices in power markets exhibit spikes and time varying volatility spikes and extremely high volatility are the results of short term frictions in demand and or supply conditions it is known that information on load or the reserve margin help to forecast spikes however these variables are not timely available for every market participant and this paper suggests to use temperature as a proxy interpreting the results from several switching regimes models the paper shows that the probability of spike occurrence increases when temperature deviates substantially from mean temperature levels

leverage effect volatility feedback and self exciting market disruptions 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 self exciting behaviors this article proposes a model that incorporates all three channels and examines their relative contribution to index option pricing and stock option pricing for different types of companies

do call prices and the underlying stock always move in the same direction this article empirically analyzes some properties shared by all one dimensional diffusion option models using sp options are not redundant securities nor ideal hedging instruments puts and the underlying asset prices may go down together much of the extant knowledge about option pricing is based on the assumption that the underlying asset price follows a one dimensional diffusion process examples of such option pricing models include the classic black scholes 1973 merton 1973 the cox ross 1976 constant elasticity of variance the ones studied in derman and kani 1994 rubinstein 1994 bergman grundy and wiener 1996 bakshi cao and chen 1997 2000 and dumas fleming and whaley 1998 all models in the one dimensional diffusion class share three basic properties first call prices are monotonically increasing and put prices are monotonically decreasing in the underlying asset price the monotonicity property second as the underlying asset price is the sole source of uncertainty for all of its options option prices must be perfectly correlated with each other and with the underlying asset the perfect

a closed form garch option valuation model this paper develops a closed form option valuation formula for a spot asset whose variance follows a garch p q process that can be correlated with the returns of the spot asset it provides the first readily computed option formula for a random volatility model that can be estimated and implemented solely on the basis of observables the single lag version of this model contains heston s 1993 stochastic volatility model as a continuous time limit empirical analysis on s p500 index options shows that the out of sample valuation errors from the single lag version of the garch model are substantially lower than the ad hoc black scholes model of dumas fleming and whaley 1998 that uses a separate implied volatility for each option to fit to the smirk smile in implied volatilities the garch model remains superior even though the parameters of the garch model are held constant and volatility is filtered from the history of asset prices while the ad hoc black scholes model is updated every period the improvement is largely due to the ability of the garch model to simultaneously capture the correlation of volatility with spot returns and the path dependence in volatility article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

option prices implied price processes and stochastic volatility this paper characterizes all continuous price processes that are consistent with current option prices this extends derman and kani 1994 dupire 1994 1997 and rubinstein 1994 who only consider processes with deterministic volatility our characterization implies a volatility forecast that does not require a specific model only current option prices we show how arbitrary volatility processes can be adjusted to fit current option prices exactly just as interest rate processes can be adjusted to fit bond prices exactly the procedure works with many volatility models is fast to calibrate and can price exotic options efficiently using familiar lattice techniques

some recent developments in futures hedging the use of futures contracts as a hedging instrument has been the focus of much research at the theoretical level an optimal hedge strategy is traditionally based on the expected utility maximization paradigm a simplification of this paradigm leads to the minimum variance criterion although this paradigm is quite well accepted alternative approaches have been sought at the empirical level research on futures hedging has benefited from the recent developments in the econometrics literature much research has been done on improving the estimation of the optimal hedge ratio as more is known about the statistical properties of financial time series more sophisticated estimation methods are proposed in this survey we review some recent developments in futures hedging we delineate the theoretical underpinning of various methods and discuss the econometric implementation of the methods

the effect of macroeconomic news on beliefs and preferences evidence from the options market we examine the effect of regularly scheduled macroeconomic announcements on the beliefs and preferences of participants in the u s treasury market by comparing the option implied state price densities spds of bond prices shortly before and after the announcements we find that the announcements reduce the uncertainty implicit in the second moment of the spd regardless of the content of the news the changes in the higher order moments in contrast depend on whether the news is good or bad for economic prospects we explore three alternative explanations for our empirical findings relative mispricing changes in beliefs and changes in preferences we find that our results are consistent with time varying risk aversion

vix derivatives hedging and vol of vol risk we study the empirical hedging performance of alternative vix option pricing models recent advances in the literature find evidence of asymmetric volatility of volatility similar to the leverage effect in equity markets stochastic mean reversion and jumps using such findings in our model framework we show that while sophisticated models have superior pricing performance and can explain a range of stylized facts in the vix derivatives market their hedging performance is inferior to a simple black model hedge we also study the empirical performance of regime dependent hedge ratio adjustments commonly applied in equity markets

local volatility and the recovery rate of credit default swaps abstract credit default swap cds spreads can only be decomposed into the probability of default and the loss given default by imposing some structure employing a hybrid binomial tree for equities and a recovery function das and hanouna 2009 obtain accurate estimates for cds spreads by fitting the model to historical equity volatilities we extend their approach by including the full implied volatility surface developing an implied binomial tree with a jump to default based on extending the derman and kani 1994 tree we then evaluate the effect of including the full volatility surface on the implied cds recovery rate

do aussie markets smile implied volatility functions and determinants if options are correctly priced the interpretation of volatility in the black scholes model as identifying the volatility of the underlying asset is violated the empirical relation between the model implied volatility and the degree to which the option is in the money moneyness has been reported as resembling a u shape or smile for options on currencies and more of a smirk for options on equities in this article using multivariate time series analysis and employing an impulse response function we investigate the structural relationships and dynamics of the volatility smile in relation to the option liquidity key features of the underlying asset and market momentum our findings confirm evidence of a number of biases in the black scholes model consistent with chou et al 2011 in regard to liquidity in both the underlying and the option itself and with pena et al 1999 as to the importance of the option time to maturity as well as delineating such biases as they co relate both with

a methodology for assessing model risk and its application to the implied volatility function model we propose a methodology for assessing model risk and apply it to the implied volatility function ivf model this is a popular model among traders for valuing exotic options our research is different from other tests of the ivf model in that we reflect the traders practice of using the model for the relative pricing of exotic and plain vanilla options at one point in time we find little evidence of model risk when the ivf model is used to price and hedge compound options however there is significant model risk when it is used to price and hedge some barrier options

the interaction of public and private insurance medicaid and the long term care insurance market a long tradition in public finance examines how public programs can crowd out private activ ity in areas as diverse as education savings and insurance among others these studies typi cally focus on aggregate economic implications particularly for government expenditures and national savings in this paper we demonstrate that crowd out can also have an important effect on individual welfare specifically we show that the provision of even very incomplete public insurance can crowd out more comprehensive private policies by imposing a large implicit tax on private insurance benefits thus potentially increasing overall risk exposure for individuals we examine the interaction of public and private insurance for one of the largest uninsured financial risks facing the elderly in the united states long term care expenditures at 135 bil lion in 2004 long term care expenditures represented over 8 5 percent of total health expendi tures or all ages or roughly 1 2 percent of gdp moreover real long term care expenditures are projected to triple over the next 35 years due to rising medical costs and the aging of the baby boomers only 10 percent of the elderly however have any private long term care insurance and one third of expenditures are paid for out of pocket congressional budget office cbo 1999 cbo 2004 brown and finkelstein 2007 one potential explanation for the small size of the private market is that the public insurance provided by medicaid may crowd out demand for private insurance medicaid was designed to provide long term care insurance for the poor elderly mark v pauly 1989 1990 has established the qualitative result that as an incomplete but publicly funded source of long term care insur ance medicaid has the potential to reduce substantially demand for private long term care insur ance even among the nonpoor our work builds on this insight by quantifying the magnitude of medicaid s crowd out effect and the incomplete nature of medicaid coverage we also illustrate the mechanism behind medicaid s crowd out effect and are therefore able to assess the likely impact of alternative policies on private insurance demand we develop a utility based model of a 65 year old risk averse individual who chooses an opti mal intertemporal consumption path in the presence of uncertainty about long term care expen ditures we calibrate the model using data on the distribution of long term care expenditure risk common state medicaid rules and the prices and coverage of typical private long term care insurance policies

hedging demands in hedging contingent claims minimum variance hedging of a contingent claim in discrete time is suboptimal when the contingent claim is hedged for multiple periods and the objective is to maximize the expected utility of cumulative hedging errors this is because the hedging errors are not independent the difference between a minimum variance hedge and the optimal multiperiod hedge is called the hedging demand and depends on the hedger s preferences the characteristics of the contingent claim the trading frequency and horizon and most importantly the joint distribution of the contingent claim and the underlying security prices since modeling this joint distribution is empirically controversial i examine nonparametrically the economic importance of hedging demands in the case of hedging standard poor s 500 index options

option prices under bayesian learning implied volatility dynamics and predictive densities abstract this paper shows that many of the empirical biases of the black and scholes option pricing model can be explained by bayesian learning effects in the context of an equilibrium model where dividend news evolve on a binomial lattice with unknown but recursively updated probabilities we derive closed form pricing formulas for european options learning is found to generate asymmetric skews in the implied volatility surface and systematic patterns in the term structure of option prices data on s p 500 index option prices is used to back out the parameters of the underlying learning process and to predict the evolution in the cross section of option prices the proposed model leads to lower out of sample forecast errors and smaller hedging errors than a variety of alternative option pricing models including black scholes and a garch model

general properties of option prices when the underlying price process is a one dimensional diffusion as well as in certain restricted stochastic volatility settings a contingent claim s delta is bounded by the infimum and supremum of its delta at maturity further if the claim s payoff is convex concave the claim s price is a convex concave function of the underlying asset s value however when volatility is less specialized or when the underlying process is discontinuous or non markovian a call s price can be a decreasing concave function of the underlying price over some range increasing with the passage of time and decreasing in the level of interest rates much of the financial options literature derives precise option prices when the underlying asset price process is completely specified since it is empirically difficult to ascertain what the true underlying process is another part of that literature is concerned with deriving general properties of option prices when the underlying price process is not fully specified but instead is assumed to belong to some general class of stochastic processes merton 1973 cox and ross 1976 jagannathan 1984 in particular in the absence of arbitrage opportunities and assuming that the risk neutralized stock price follows a proportional stochastic process a risk neutral return distribution independent of price merton 1973 and jagannathan 1984 show that a call option s price is an increasing convex function of the stock price cox and ross 1976

implied volatility dynamics in the foreign exchange markets abstract the purpose of this study is to examine the dynamics of implied volatilities derived from the major currency options on futures several studies have examined the properties of implied volatilities in the equity and interest markets however very little is known about the dynamics of implied volatilities derived from the currency options markets which is the subject of this paper the results show that participants in the currency market tend to expect higher future volatility when the currency market fluctuates in a large scale regardless of the direction implying that uncertainty as measured by implied volatility would be higher when movements of exchange rates are large we also provide evidence that in the foreign exchange markets the traders trading pattern or the private information in addition to the public information also drive the intraweek implied volatility patterns finally we document that it would be difficult to earn abnormal trading profits with portfolios based on the observed patterns of implied volatilities and conclude that the foreign exchange options on futures market is efficient in this sense

the economic determinants of interest rate option smiles we address three questions relating to the interest rate options market what is the shape of the smile what are the economic determinants of the shape of the smile do these determinants have predictive power for the future shape of the smile and vice versa we investigate these issues using daily bid and ask prices of euro interest rate caps floors we find a clear smile pattern in interest rate options the shape of the smile varies over time and is affected in a dynamic manner by yield curve variables and the future uncertainty in the interest rate markets it also has information about future aggregate default risk our findings are useful for the pricing hedging and risk management of these derivatives

dynamic jump intensities and risk premiums evidence from s p500 returns and options we build a new class of discrete time models that are relatively easy to estimate using returns and or options the distribution of returns is driven by two factors dynamic volatility and dynamic jump intensity each factor has its own risk premium the models significantly outperform standard models without jumps when estimated on s p500 returns we find very strong support for time varying jump intensities compared to the risk premium on dynamic volatility the risk premium on the dynamic jump intensity has a much larger impact on option prices we confirm these findings using joint estimation on returns and large option samples

seasonal factors and outlier effects in rate of return on electricity spot prices in australia s national electricity market this article documents seasonal patterns and other characteristics of electricity spot prices in the australian national electricity market nem over a 7 year sample period the goal is to investigate more specifically the influence of seasonalities and outliers noted in the body of literature on electricity prices the results confirm that electricity prices exhibit significant time of day and day of week effects and monthly and yearly effects are significant to a lesser degree extremely high spikes in the price series are an important characteristic of electricity prices and are shown to be a highly significant component of returns behaviour negative prices are unusual in financial time series data but occur in australian electricity prices and are found to be influential on returns the implications of these finding are that seasonal and outlier effects should not be ignored in efforts to model electricity prices

implied volatility functions empirical tests derman and kani 1994 dupire 1994 and rubinstein 1994 hypothesize that asset return volatility is a deterministic function of asset price and time and develop a deterministic volatility function dvf option valuation model that has the potential of fitting the observed cross section of option prices exactly using s p 500 options from june 1988 through december 1993 we examine the predictive and hedging performance of the dvf option valuation model and find it is no better than an ad hoc procedure that merely smooths black scholes 1973 implied volatilities across exercise prices and times to expiration

carbon pricing and electricity markets the case of the australian clean energy bill abstract we examine the impact of the clean energy bill on the price behavior of electricity futures contracts in the australian national electricity market first we compute ex ante forward risk premiums in the pre tax period until june 2012 then derive market implied expectations about additional costs of the carbon pricing mechanism cpm on generators as well as pass through rates during the carbon tax july 2012 june 2014 and post tax after july 2014 periods our results suggest that the observed carbon premiums became increasingly higher once the carbon tax had been proposed and subsequently legislated in 2011 during periods where market participants could be relatively certain that the tax would be effective we find expected carbon pass through rates between 67 and 150 which seem to be inversely related to emission intensities in the regional markets our results are also a clear indication of strong policy uncertainty with regards to the cpm and suggest that in the future a stable and long term policy framework would be required for a carbon pricing mechanism to have its full effect

uncertain medical expenses and precautionary saving near the end of the life cycle this paper introduces a dynamic structural model of household consumption decisions in which elderly families consider the effects of uncertain future medical expenses when deciding current levels of consumption the model with uncertain medical expenses implies a potentially important role for precautionary saving incentives to explain slow rates of dissaving among elderly americans during retirement rather than just simulating the stochastic dynamic model preference parameters are estimated using panel data on health wealth and expenditures for retired families the health uncertainty model predicts consumption levels closer to observed expenditures than a life cycle model with uncertain longevity however elderly families typically dissave their financial assets more slowly than even the baseline health uncertainty model predicts is optimal

effects of the volatility smile on exchange settlement practices the hong kong case abstract the well documented volatility smile phenomenon in the us options market has affected the option settlement practices of other markets to settle hang seng index hsi options the hong kong stock exchange artificially builds in a piecewise linear smile or sneer volatility function which is determined daily by market makers rather than directly by market forces in this study we investigate the time varying settlement function and find the following economic determinants of the volatility function lag parameters current day hsi returns the distribution of hsi returns transaction costs as proxied by the bid ask spread and the monday effect for evaluation purposes we use as a benchmark the estimated piecewise linear volatility function as directly driven by market forces the comparison analyses show that base volatilities set by market makers run somewhat high while downside slopes are not steep enough this results in the overpricing of the lion s share of traded options an economic determinants analysis of market force driven parameters reveals that market makers can better align artificial volatility parameters both by reducing reliance on the function parameters of prior days and by more precisely accounting for current day hsi returns option time to maturity bid ask spreads and buying pressure

spot and derivative pricing in the eex power market using spot and futures price data from the german eex power market we test the adequacy of various one factor and two factor models for electricity spot prices the models are compared along two different dimensions 1 we assess their ability to explain the major data characteristics and 2 the forecasting accuracy for expected future spot prices is analyzed we find that the regime switching models clearly outperform its competitors in almost all respects the best results are obtained using a two regime model with a gaussian distribution in the spike regime furthermore for short and medium term periods our results underpin the frequently stated hypothesis that electricity futures quotes are consistently greater than the expected future spot a situation which is denoted as contango

modeling extreme dependence between european electricity markets electricity spot prices are characterized by sudden large movements followed a few days later by an equally large movement in the opposite direction these phenomena are called spikes upward movements and drops downward movements recent research has suggested that the dynamics of the electricity spot prices can be accurately described by hidden markov regime switching mrs models regime switch models separate the ordinary dependence and the extreme spike or drop dependence this is a crucial point since it is the extreme dependence that is of interest when computing risks we fit a large number of mrs models to six european electricity markets eex powernext apx power uk nl nord pool system sweden in order to analyze the nature of the prices the estimated regimes are then used to analyze the probability of an extreme event and the conditional probability for one market to experience an extreme event conditional that another market is experiencing the same event we find that the frequency of extreme events is positively related to the amount of renewable energy sources in the power system it can be argued that the dependence results in this paper give an indication of what future dependence for even more integrated markets with more renewable energy will be the integration of markets will lead to efficient sharing of reserves while the additional renewable energy will increase the need for reserves the results are of interest when computing financial risks e g var or expected shortfall when designing reserves but also as an indication of the degree of integration between markets

are current syndicated loan alliances related to past alliances abstract the odds of a current syndicate relationship between two lenders depend upon their previous alliances the odds are significantly higher lower and strongest for a current lead participant relationship with a continuation reversal of their previous roles to illustrate the odds are nearly four times higher when two lenders have allied in the previous 5 years the strength of lead participant syndicate relationships between two lenders with same ordered roles is most sensitive to the lead bank s reputation and informationally opaque participants tend to have stronger relationships with lead banks lenders exhibit home bias in their syndicate alliances since ongoing relationships are stronger with domestic counterparts

how important is the correlation between returns and volatility in a stochastic volatility model empirical evidence from pricing and hedging in the s p 500 index options market abstract this paper examines the importance of allowing for correlation between returns and volatility in a continuous time stochastic volatility option pricing model specifically it tests the closed form stochastic volatility model of heston review of financial studies 6 1993 327 343 that allows for non zero correlation in terms of pricing and hedging options on the s p 500 index it is found that non zero correlation in the stochastic volatility model leads to significant improvements in mispricing of out of the money options and overall pricing performance compared to if correlation is constrained to be zero in terms of hedging non zero correlation results in significantly lower hedging errors for out of the money options

the price of a smile hedging and spanning in option markets the volatility smile changed drastically around the crash of 1987 and new option pricing models have been proposed to accommodate that change deterministic volatility models allow for more flexible volatility surfaces but refrain from introducing additional risk factors thus options are still redundant securities alternatively stochastic models introduce additional risk factors and options are then needed for spanning of the pricing kernel we develop a statistical test based on this difference in spanning using daily s p 500 index options data from 1986 95 our tests suggest that both in and out of the money options are needed for spanning the findings are inconsistent with deterministic volatility models but are consistent with stochastic models that incorporate additional priced risk factors such as stochastic volatility interest rates or jumps article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

nursing home residents make a difference the overestimation of saving rates at older ages while life cycle theory makes the clear prediction that people dissave at old age this prediction is not at all borne out by the data from many countries various suggestions have been made to explain this discrepancy this paper sheds more light on the effect of the exclusion of institutionalized individuals in estimating saving rates over old age a conceptual aspect often mentioned but never investigated particularly this group is expected to decumulate wealth since nursing home expenses net of private and public insurance exceed disposable income on average this paper uses data from the u s and germany to show that there is an increasing overestimation of saving rates from age 75 on if institutionalized households are not included the effect on aggregate saving rates caused by the exclusion of the nursing home population becomes even more important in the face of population aging specifically this paper quantifies this effect using the health and retirement study hrs for the usa the overestimation of the mean median saving rates is 3 3 percentage points 4 3pp at age 80 5 4pp 9 4pp at age 90 and even more for age 90 based on the german income and expenditure survey evs the overestimation of the german mean saving rate increases to almost 6pp at age 90 this strong overestimation is based on the fact that nursing home residents strongly reduced their wealth holdings referring to the usa the median single nursing home resident reduces wealth holdings by 90 over a two year period the mean single nursing home r esident diminishes total net wealth by 19 the dissaving is less strong for couples

throwing away a billion dollars the cost of suboptimal exercise strategies in the swaptions market abstract this paper studies the costs of applying single factor exercise strategies to american swap options when the term structure is actually driven by multiple factors using a multifactor string market model of the term structure we find that even when single factor models are recalibrated to match the market at every exercise date the exercise strategies they imply can be suboptimal based on estimates of notional amounts outstanding the total present value costs of following single factor strategies could be several billion dollars these results illustrate the importance of using well specified term structure models

differential mortality and wealth accumulation the issue of asset accumulation and decumulation is central to the life cycle theory of consumer behavior and to many policy questions one of the main implications of the life cycle model is that assets are decumulated in the last part of life most empirical studies in this area use cross sectional data of estimate mean or median wealth age profiles the use of cross sections to estimate the age profile of assets is full of pitfalls for example if wealth and mortality are related in that poorer individuals die younger one overestimates the last part of the wealth age profile when using cross sectional data because means or other measures of location are taken over a population which becomes richer as it ages this paper examines the effect of differential mortality on cross sectional estimates of wealth age profiles our approach is to quantify the dependence of mortality rates on wealth and use these estimates to correct wealth age profiles for sample selection due to differential mortality we estimate mortality rates as a function of wealth and age for a sample of married couples drawn from the survey of income and program participation sipp our results show that accounting for differential mortality produces wealth profiles with significantly more dissaving among the elderly

an analytical approximation formula for european option pricing under a new stochastic volatility model with regime switching abstract in this paper an analytical approximation formula for pricing european options is obtained under a newly proposed hybrid model with the volatility of volatility in the heston model following a markov chain the adoption of which is motivated by the empirical evidence of the existence of regime switching in real markets we first derive the coupled pde partial differential equation system that governs the european option price which is solved with the perturbation method it should be noted that the newly derived formula is fast and easy to implement with only normal distribution function involved and numerical experiments confirm that our formula could provide quite accurate option prices especially for relatively short tenor ones finally empirical studies are carried out to show the superiority of our model based on s p 500 returns and options with the time to expiry less than one month

opaque financial reports r2 and crash risk abstract we investigate the relation between the transparency of financial statements and the distribution of stock returns using earnings management as a measure of opacity we find that opacity is associated with higher r2s indicating less revelation of firm specific information moreover opaque firms are more prone to stock price crashes consistent with the prediction of the jin and myers 2006 r2 around the world new theory and new tests journal of financial economics 79 257 292 model however these relations seem to have dissipated since the passage of the sarbanes oxley act suggesting that earnings management has decreased or that firms can hide less information in the new regulatory environment

errors in implied volatility estimation estimating implied volatility by inverting the black scholes formula is subject to considerable error when option characteristics are observed with plausible errors especially for options away from the money large changes in volatility produce small changes in option prices conversely small errors in option prices and other option characteristics produce large errors in implied volatilities in the presence of small measurement errors unobserved truncation of option prices that violate lower bounds for absence of arbitrage can also lead to systematic volatility smiles the paper proposes feasible gls estimators that reduce the noise and bias in implied volatility estimates

modeling and forecasting multivariate electricity price spikes abstract we consider the problem of forecasting the occurrence of extreme prices in the australian electricity markets from high frequency spot prices in particular we are interested in the simultaneous occurrence of such so called spikes in two or more markets our approach is based on a novel dynamic model for multivariate binary outcomes which allows the latent variables driving these observed outcomes to follow a vector autoregressive process furthermore the model is constructed using a copula representation for the joint distribution of the resulting innovations this has several advantages over the standard multivariate probit model first it allows for nonlinear dependence between the error terms second the distribution of the latent errors can be chosen freely third the computational burden can be greatly reduced making estimation feasible in higher dimensions and for large samples the model is applied to spikes in half hourly electricity prices in four interconnected australian markets the multivariate model provides a superior fit compared to single equation models and generates better forecasts for spike probabilities furthermore evidence of spillover dynamics between the markets is revealed

tranching in the syndicated loan market around the world loan tranching allows banks to manage risk and facilitate firm financing which may be essential for firms that cannot access investors from stock markets we analyze the determinants and benefits of loan tranching by pooling the tranches of individual loans to create the largest cross country sample of syndicated loans covering more than 150 000 loans from multinational and domestic firms we find that in addition to market deal and borrower characteristics legal and institutional differences impact loan tranching strong creditor protection and efficient debt collection increase the probability of tranching and reduce tranche spreads ultimately promoting firms access to debt we also find evidence that tranching facilitates the financing of multinational firms abroad due to the transfer of legal and cultural institutions to foreign subsidiaries overall our results suggest that tranching plays an important role in reducing a country s financial development gap and promotes firms access to debt

producing derivative assets with forward contracts this paper shows how a derivative security can be duplicated by a forward strategy and hence priced by arbitrage in terms ofthe forward price