can portmanteau nonlinearity tests serve as general mis specification tests a number of recent papers have employed the bds test as a general test for mis specification for linear and nonlinear models we show that for a particular class of conditionally heteroscedastic models the bds test is unable to detect a common mis specification our results also demonstrate that specific rather than portmanteau diagnostics are required to detect neglected asymmetry in volatility however for both classes of tests reasonable power is only obtained using very large sample sizes

strategic behavior and partial cost sharing abstract the main objects here are games in which players mainly compete but nonetheless collaborate on some subsidiary activities play assumes a two stage nature in that first stage moves presume coordination of some subsequent tasks specifically we consider instances where second stage coordination amounts to partial cost sharing anticipated and sustained as a core solution examples include regional cournot oligopolies with joint transportation we define and characterize equilibria and inquire about their existence

model choice and value at risk performance broad agreement exists among both the investment banking and regulatory communities that the use of internal risk management models is an efficient means for calculating capital risk requirements the determination of model parameters laid down by the basle committee on banking supervision as necessary for estimating and evaluating the capital adequacies however has received little academic scrutiny we investigate a number of issues of statistical modeling in the context of determining market based capital risk requirements we highlight several potentially serious pitfalls in commonly applied methodologies and conclude that simple methods for calculating value at risk often provide superior performance to complex procedures our results thus have important implications for risk managers and market regulators

testing for nonlinear dependence in daily foreign exchange rates the purpose of this article is to investigate whether daily changes in five major foreign exchange rates contain any nonlinearities although the data contain no linear correlation evidence indicates the presence of substantial nonlinearity in a multiplicative rather than additive form further examination reveals that a generalized autoregressive conditional heteroskedasticity model can explain a large part of the nonlinearities for all five exchange rates copyright 1989 by the university of chicago

answering the skeptics yes standard volatility models do provide accurate forecasts a voluminous literature has emerged for modeling the temporal dependencies in financial market volatility using arch and stochastic volatility models while most of these studies have documented highly significant in sample parameter estimates and pronounced intertemporal volatility persistence traditional ex post forecast evaluation criteria suggest that the models provide seemingly poor volatility forecasts contrary to this contention we show that volatility models produce strikingly accurate interdaily forecasts for the latent volatility factor that would be of interest in most financial applications new methods for improved ex post interdaily volatility measurements based on high frequency intradaily data are also discussed

economic determinants of oil futures volatility a term structure perspective to assess the economic determinants of oil futures volatility we firstly develop and estimate a multi factor oil futures pricing model with stochastic volatility that is able to disentangle long term medium term and short term variations in commodity markets volatility the volatility estimates reveal that in line with theory the volatility factors are unspanned persistent and carry negative market price of risk while crude oil markets are becoming more integrated with financial markets after 2004 short term volatility is driven by industrial production term and credit spreads the s p 500 and the us dollar index along with the traditional drivers including hedging pressure and vix medium term volatility is consistently related to open interest and credit spreads while after 2004 oil sector variables such as inventory and consumption also impact this part of the term structure interest rates mostly matter for long term futures price volatility

stochastic convenience yield and the pricing of oil contingent claims this paper develops and empirically tests a two factor model for pricing financial and real assets contingent on the price of oil the factors are the spot price of oil and the instantaneous convenience yield the parameters of the model are estimated using weekly oil futures contract prices from january 1984 to november 1988 and the model s performance is assessed out of sample by valuing futures contracts over the period november 1988 to may 1989 finally the model is applied to determine the present values of one barrel of oil deliverable in one to ten years time

nonlinear nonparametric nonessential exchange rate estimation a wide variety of empirical exchange rate mo dels have been estimated over the years but despite the considerable energies that have been devoted to this work the economics profession has remarkably little to show for itself there is little evidence that conclusively links the bilateral exchange rates of typical oecd countries to fundamental macroeconomic determinants of exchange rates such as money output relative prices or interest differentials coefficient estimates are notoriously unstable and frequently mis signed compared with theoretical predictions exchange rate equations do not fit particularly well and forecast no better than the simplest naive alternatives recently a new class of exchange rate models was introduced by paul krugman 1988 these models provide a potential reason for the poor performance of traditional exchange rate models because they are nonlinear if the exchange rate actually depends in a nonlinear way on exogenous macroeconomic fundamentals linear exchange rate models may work poorly even though the exchange rate is closely linked to fundamentals in this paper we provide a brief sketch of some of this work as well as some preliminary evidence on the actual performance of these nonlinear models in our empirical analysis we use a nonparametric estimator that can handle a wide variety of nonlinear phenomena we examine fixed exchange rate regimes where nonlinearities should be quite easy to detect however we do not find strong empirical support for the hypothesis that the incorporation of nonlinear effects significantly improves models of exchange rate determination in section i we briefly review the theoretical literature on nonlinear target zone exchange rate models linking this work to the tests for intrinsic bubbles we draw heavily on recent papers by kenneth froot and maurice obstfeld 1989a b our methodology and data are discussed in section ii section iii contains new empirical tests for nonlinearities in exchange rate models

the effect of asymmetries on optimal hedge ratios there is widespread evidence that the volatility of stock returns displays an asymmetric response to good and bad news this article considers the impact of asymmetry on time varying hedges for financial futures an asymmetric model that allows forecasts of cash and futures return volatility to respond differently to positive and negative return innovations gives superior in sample hedging performance however the simpler symmetric model is not inferior in a hold out sample a method for evaluating the models in a modern risk management framework is presented highlighting the importance of allowing optimal hedge ratios to be both time varying and asymmetric

time irreversibility and egarch effects in us stock index returns in this paper we suggest using a modified version of the time reversibility tr test of chen chou and kuan 2000 as a complementary diagnostic test for time series models the modified cck test is easy to compute and requires weaker moment conditions than existing tests our simulations demonstrate that this test is powerful against asymmetry in volatility but the bds test is not in the empirical study of us stock index returns we first find that these returns are all time irreversible applying the garch and egarch models to these returns we also find that the q and bds tests always accept the null hypothesis and cannot distinguish between these models by contrast the modified cck test accepts only the egarch model with an order that can accommodate the underlying asymmetry in volatility our results suggest that the detected time irreversibility in these return series may be attributed to volatility asymmetry and that such asymmetry may be captured using a proper egarch model copyright 2002 john wiley sons ltd

bond pricing and the term structure of interest rates a new methodology for contingent claims valuation this paper presents a unifying theory for valuing contingent claims under a stochastic term structure of interest rates the methodology based on the equivalent martingale measure technique takes as given an initial forward rate curve and a family of potential stochastic processee for its subsequent movements a no arbitrage condition restricts this family of processes yielding valuation formulae for interest rate sensitive contingent claims which do not explicitly depend on the market prices of risk examples are provided to illustrate the key results in relation to the term structure of interest rates arbitrage pricing theory has two purposes the first is to price all zero coupon default free bonds of varying maturities from a finite number of economic fundamentals called state variables the second is to price all interest rate sensitive contingent claims taking as given the prices of the zero coupon bonds this paper presents a general theory and a unifying framework for understanding arbitrage pricing theory in this context of which all existing arbitrage pricing models are special cases in particular vasicek 1977 brennan and schwartz 1979 langetieg 1980 ball and torous 1983 ho and lee 1986 schaefer and schwartz 1987 and artzner and delbaen 1988 the primary contribution of this paper however is a new methodology for solving the second problem i e the pricing of interest rate sensitive contingent claims given the prices of all zero coupon bonds the methodology is new because i it imposes its stochastic structure directly on the evolution of the forward rate curve ii it does not require an inversion of the term structure to eliminate the market prices of risk from contingent claim values and iii it has a stochastic spot rate process with multiple stochastic factors influencing the term structure the model can be used to consistently price and hedge all contingent claims american or european on the term structure and it is derived from necessary and more importantly sufficient conditions for the absence of arbitrage the arbitrage pricing models of vasicek 1977 brennan and schwartz 1979 langetieg 1980 and artzner and delbaen 1988 all require an iformerly titled bond pricing and the term structure of interest rates a new methodology

learning convergence and stability with multiple rational expectations equilibria abstract for a linear model with multiple rational expectations equilibria ree we discuss the set of possible ree solutions include i locally unique minimal state variable solutions taking an ar 1 form and ii continua of solutions which may depend on sunspots we analyze the convergence of econometric learning to the different ree there exist cases with more than one stable ar 1 solution it is also possible for a continuum of solutions to be stable but this property is not robust to overparametrization an application is developed and it is suggested that the exhibited phenomena may arise in applied macroeconomic models

nonlinearity and intraday efficiency tests on energy futures markets using high frequency data this paper first time comprehensively examines the intraday efficiency of four major energy crude oil heating oil gasoline natural gas futures markets in contrast to earlier studies which focus on in sample evidence and assume linearity the paper employs various nonlinear models and several model evaluation criteria to examine market efficiency in an out of sample forecasting context overall there is evidence for intraday market inefficiency of two of the four energy future markets heating oil and natural gas which exists particularly during the bull market condition but not during the bear market condition the evidence is also robust against the data snooping bias and the model overfitting problem and its economic significance can be very substantial

the statistical properties of daily foreign exchange rates 1974 1983 abstract this paper examines the statistical properties of daily rates of change of five foreign currencies from 1974 to 1983 the main purpose is to discriminate between two competing explanations for the observed heavy tails of the distribution that the data are independently drawn from a heavy tail distribution which remains fixed over time and that the data come from distributions which vary over time evidence point to the rejection of the first hypothesis further investigations show that the rejection can be attributed to changing means and variances in the data which can be described by a simple statistical model

nonlinear dynamics in financial markets evidence and implications daily asset returns exhibit two key statistical properties price changes are not autocorrelated but the absolute values of changes are strongly autocorrelated nonlinear processes can generate this type of behavior linear processes cannot additively nonlinear processes are consistent with the view that expected returns are time varying although much effort has been applied to modeling expected returns there has been little evidence to support the view that time varying expected returns can account for the strong nonlinearity in the observed returns data multiplicatively nonlinear models are consistent with the view that expected volatilities are time varying evidence from price changes as well as options implied volatilities show that volatility is time varying and mean reverting in fact multiplicatively nonlinear models have been able to explain a great deal of the nonlinearity in asset returns thus future volatility can be forecast even though the direction of price changes is difficult

a continuous approach to oligopolistic market equilibrium we provide an algorithm for computing cournot nash equilibria in a market that involves finitely many producers the algorithm amounts to following a certain dynamical system all the way to its steady state which happens to be a noncooperative equilibrium the dynamics arise quite naturally as follows let each producer continuously adjust the planned production if desired as a response to the current aggregate supply in doing so the producer is completely guided by myopic profit considerations we show under broad hypothesis that this adjustment process is globally asymptotically convergent to a nash equilibrium

the statistical distribution of exchange rates empirical evidence and economic implications the abundant evidence that changes in exchange rates have distributions with fatter tails than the normal distribution has led researchers to consider non normal distributions including the student the stable paretian and mixtures of distributions this paper compares the empirical fits of three non normal candidates and the normal distribution for daily changes in the logarithms of exchange rates using maximum likelihood estimation of the parameters and chi square goodness of fit tests the student and mixture of two normals provide the best fits but there is evidence that the distribution parameters may vary over time

on the stability of an adjustment process for spatial price equilibrium modeled as a projected dynamical system abstract this paper presents a stability study for the continuous time adjustment process proposed for the perfectly competitive spatial price equilibrium problem modeled as a projected dynamical system by nagurney takayama and zhang 1995 two distinct approaches are adopted here for establishing the stability of the spatial price equilibrium under such an adjustment process one approach utilizes the monotonicity condition on the supply prices demand prices and transaction costs to develop various stability properties the other utilizes the regularity concept adapted from zhang and nagurney 1995 which enables us to explore the stability of the adjustment process a nonstandard dynamical system via its minimal face flow a standard dynamical system

nonlinear dynamics and stock returns simple deterministic systems are capable of generating chaotic output that mimics the output of stochastic systems for this reason algorithms have been developed to distinguish between these two alternatives these algorithms and related statistical tests are also useful in detecting the presence of nonlinear dependence in time series in this article the authors apply these procedures to stock returns and find evidence that indicates the presence of nonlinear dependence on weekly returns from the center for research in security prices value weighted index copyright 1989 by the university of chicago

computing the market price of volatility risk in the energy commodity markets abstract in this paper we demonstrate the need for a negative market price of volatility risk to recover the difference between black scholes black f scholes m 1973 the pricing of options and corporate liabilities journal of political economy 81 637 654 black black f 1976 studies of stock price volatility changes in proceedings of the 1976 meetings of the business and economics statistics section american statistical association pp 177 181 implied volatility and realized term volatility initially using quasi monte carlo simulation we demonstrate numerically that a negative market price of volatility risk is the key risk premium in explaining the disparity between risk neutral and statistical volatility in both equity and commodity energy markets this is robust to multiple specifications that also incorporate jumps next using futures and options data from natural gas heating oil and crude oil contracts over a 10 year period we estimate the volatility risk premium and demonstrate that the premium is negative and significant for all three commodities additionally there appear distinct seasonality patterns for natural gas and heating oil where winter withdrawal months have higher volatility risk premiums computing such a negative market price of volatility risk highlights the importance of volatility risk in understanding priced volatility in these financial markets

do euro exchange rates follow a martingale some out of sample evidence abstract traditional autocorrelation and variance ratio tests are based on serial uncorrelatedness rather than martingale difference as such they do not capture potential nonlinearity in mean which could lead to misleading inferences in favor of the martingale hypothesis this paper employs various parametric and nonparametric nonlinear models as well as several model comparison criteria to examine the potential martingale behavior of euro exchange rates in the context of out of sample forecasts the overall evidence indicates that while martingale behavior cannot be rejected for euro exchange rates with major currencies such as the japanese yen british pound and us dollar there is nonlinear predictability in terms of economic criteria with respect to several smaller currencies

a word of caution on calculating market based minimum capital risk requirements this paper demonstrates that the use of garch type models for the calculation of minimum capital risk requirements mcrrs may lead to the production of inaccurate and therefore inefficient capital requirements we show that this inaccuracy stems from the fact that garch models typically overstate the degree of persistence in return volatility a simple modification to the model is found to improve the accuracy of mcrr estimates in both back and out of sample tests given that internal risk management models are currently in widespread usage in some parts of the world most notably the usa and will soon be permitted for ec banks and investment firms we believe that our paper should serve as a valuable caution to risk management practitioners who are using or intend to use this popular class of models

approaches to economic equilibrium abstract we study mechanisms that help to explain why and how equilibrium may eventually be attained in many economic settings examples include competitive markets and many noncooperative games the main object is an adaptive process reflecting repeated adjustment of individual strategies which under monotonicity conditions leads to equilibrium environmental uncertainty is accommodated but agents need neither know the probability law nor invoke any statistical learning theory nor compute mean values in fact everyone can act perhaps without precedent maybe among strangers within unidentified frames nonetheless we show under reasonable conditions that individual optimality and system equilibrium obtains in the long run

hedging in the possible presence of unspanned stochastic volatility evidence from swaption markets this paper examines whether higher order multifactor models with state variables linked solely to underlying libor swap rates are by themselves capable of explaining and hedging interest rate derivatives or whether models explicitly exhibiting features such as unspanned stochastic volatility are necessary our research shows that swaptions and even swaption straddles can be well hedged with libor bonds alone we examine the potential benefits of looking outside the libor market for factors that might impact swaption prices without impacting swap rates and find them to be minor indicating that the swaption market is well integrated with the libor swap market

volatility in crude oil futures a comparison of the predictive ability of garch and implied volatility models the wti future contract quoted at the nymex is the most actively traded instrument in the energy sector this paper compares the predictive ability of two approaches which can be used to forecast volatility garch type models where forecasts are obtained after estimating time series models and an implied volatility model where forecasts are obtained by inverting one of the models used to price options although the main scope of the research discussed here is to evaluate which model produces the best forecast of volatility for the wti future contract evaluated according to statistical and regression based criteria we also investigate whether volatility of the oil futures are affected by asymmetric effects whether parameters of the garch models are influenced by the distribution of the errors and whether allowing for a time varying long run mean in the volatility produces any improvement on the forecast obtained from garch models

iterative computation of cournot equilibrium abstract in a homogeneous coumot model with quasi concave profit functions the problem of determining an equilibrium can be posed as one of solving an equation in one real variable total sales if the response functions are monotone or firms are identical then a certain iterative process based on averaging converges to an equilibrium such iterations have the interpretation that every firm responds to the average of sales by other firms in brevious periods

valuation of commodity futures and options under stochastic convenience yields interest rates and jump diffusions in the spot this paper investigates the effects of stochastic convenience yields stochastic interest rates and jumps in the spot price on the pricing of commodity futures forwards and futures options numerical examples show that one factor prices differ materially from the stochastic convenience yield two factor prices when convenience yield is considerably above its long term average the extension to a three factor model with stochastic interest rates leads to a different futures price but the forward price is unchanged the extension ofthe three factor model to include jumps in the spot price process does not affect forward or futures prices but it can have an impact on options prices the model is applied to price the present value of future cash flows from a real asset

do bonds span the fixed income markets theory and evidence for unspanned stochastic volatility most term structure models assume bond markets are complete that is that all fixed income derivatives can be perfectly replicated using solely bonds however we find that in practice swap rates have limited explanatory power for returns on at the money straddles portfolios mainly exposed to volatility risk we term this empirical feature unspanned stochastic volatility usv while usv can be captured within an hjm framework we demonstrate that bivariate models cannot exhibit usv we determine necessary and sufficient conditions for trivariate markov affine systems to exhibit usv for such usv models bonds alone may not be sufficient to identify all parameters rather derivatives are needed

understanding index option returns this paper studies the returns from investing in index options previous research documents significant average option returns large capm alphas and high sharpe ratios and concludes that put options are mispriced we propose an alternative approach to evaluate the significance of option returns and obtain different conclusions instead of using these statistical metrics we compare historical option returns to those generated by commonly used option pricing models we find that the most puzzling finding in the existing literature the large returns to writing out of themoney puts is not even inconsistent with the black scholes model moreover simple stochastic volatility models with no risk premia generate put returns across all strikes that are not inconsistent with the observed data at the money straddle returns are more challenging to understand and we find that these returns are not inconsistent with explanations such as jump risk premia peso problems and estimation risk

humps in the volatility structure of the crude oil futures market new evidence abstract this paper analyses the volatility structure of commodity derivatives markets the model encompasses hump shaped unspanned stochastic volatility which entails a finite dimensional affine model for the commodity futures curve and quasi analytical prices for options on commodity futures using an extensive database of crude oil futures and futures options spanning 21 years we find the presence of hump shaped partially spanned stochastic volatility in the crude oil market the hump shaped feature is more pronounced when the market is more volatile and delivers better pricing as well as hedging performance under various dynamic factor hedging schemes

nonlinearity data snooping and stock index etf return predictability abstract this paper examines daily return predictability for eighteen international stock index etfs the out of sample tests are conducted based on linear and various popular nonlinear models and both statistical and economic criteria for model comparison the main results show evidence of predictability for six of eighteen etfs a simple linear autoregression model and a nonlinear in variance garch model but not several popular nonlinear in mean models help outperform the martingale model the allowance of data snooping bias using white s reality check also substantially weakens otherwise apparently strong predictability

from the samuelson volatility effect to a samuelson correlation effect an analysis of crude oil calendar spread options abstract our first aim in this paper is to introduce a futures based model able of capturing the main features displayed by crude oil futures and options contracts such as the samuelson volatility effect and the volatility smile we calculate the joint characteristic function of two futures contracts in the model in analytic form and use it to price calendar spread options in an empirical application we show that the model in contrast to simpler nested models can be successfully calibrated to market prices of vanilla and calendar spread options our second aim is to use this model to analyze the dependence structure of crude oil futures contracts to this end we propose analytical expressions giving the copula and copula density directly in terms of the joint characteristic function these tools allow us to perform an in depth analysis for pairs of futures and we observe a phenomenon we call the samuelson correlation effect

pricing of options on commodity futures with stochastic term structures of convenience yields and interest rates we develop a model to value options on commodity futures in the presence of stochastic interest rates as well as stochastic convenience yields in the development of the model we distinguish between forward and future convenience yields a distinction that has not been recognized in the literature assuming normality of continuously compounded forward interest rates and convenience yields and log normality of the spot price of the underlying commodity we obtain closed form solutions generalizing the black scholes merton s formulas we provide numerical examples with realistic parameter values showing that both the effect of introducing stochastic convenience yields into the model and the effect of having a short time lag between the maturity of a european call option and the underlying futures contract have significant impact on the option prices

unspanned stochastic volatility and the pricing of commodity derivatives commodity derivatives are becoming an increasingly important part of the global derivatives market here we develop a tractable stochastic volatility model for pricing commodity derivatives the model features unspanned stochastic volatility quasi analytical prices of options on futures contracts and dynamics of the futures curve in terms of a low dimensional affine state vector we estimate the model on nymex crude oil derivatives using an extensive panel data set of 45 517 futures prices and 233 104 option prices spanning 4082 business days we find strong evidence for two predominantly unspanned volatility factors jel g13

the weak axiom of revealed preference in a productive economy we consider an economy with pure factors of production private ownership of endowments and constant returns to scale in production typically in such an economy the weak axiom of revealed preference for market demand does not hold the main reason for this is that the income distribution in such a private ownership economy depends too sensitively on the price system

implications of nonlinear dynamics for financial risk management this paper demonstrates that when log price changes are not iid their conditional density may be more accurate than their unconditional density for describing short term behavior using the bds test of independence and identical distribution daily log price changes in four currency futures contracts are found to be not iid while there appear to be no predictable conditional mean changes conditional variances are predictable and can be described by an autoregressive volatility model that seems to capture all the departures from independence and identical distribution based on this model daily log price changes are decomposed into a predictable part which is described parametrically by the autoregressive volatility model and an unpredictable part which can be modeled by an empirical density either parametrically or nonparametrically this two step seminonparametric method yields a conditional density for daily log price changes which has a number of uses in financial risk management

pricing of long dated commodity derivatives do stochastic interest rates matter abstract does modelling stochastic interest rates beyond stochastic volatility improve pricing performance on long dated commodity derivatives to answer this question we consider futures price models for commodity derivatives that allow for stochastic volatility and stochastic interest rates and a correlation structure between the underlying variables we examine the empirical pricing performance of these models on pricing long dated crude oil derivatives estimating the model parameters from historical crude oil futures prices and option prices we find that stochastic interest rate models improve pricing performance on long dated crude oil derivatives when the interest rate volatility is relatively high furthermore increasing the model dimensionality does not tend to improve the pricing performance on long dated crude oil option prices but it matters for long dated futures prices we also find empirical evidence for a negative correlation between crude oil futures prices and interest rates that contributes to improving fit to long dated crude oil option prices

how relevant is volatility forecasting for financial risk management it depends if volatility fluctuates in a forecastable way volatility forecasts are useful for risk management hence the interest in volatility forecastability in the risk management literature volatility forecastability however varies with horizon and different horizons are relevant in different applications moreover existing assessments of volatility forecastability are plagued by the fact that they are joint assessments of volatility forecastability and an assumed model and the results can vary not only with the horizon but also with the assumed model to address this problem we develop a model free procedure for assessing volatility forecastability across horizons perhaps surprisingly we find that volatility forecastability decays quickly with horizon volatility forecastability although clearly of relevance for risk management at the short horizons relevant for say trading desk management may be much less important at longer horizons

the conditional heteroscedasticity of the yen dollar exchange rate this paper examines the conditional heteroscedasticity of the yen dollar exchange rate a model is constructed by extending the asymmetric power autoregressive conditional heteroscedasticity model to a process that is fractionally integrated it is found that unlike the equity markets the appreciation and depreciation shocks of the yen against the dollar have similar effects on future volatilities although the results reject both the stable and the integrated models our analysis of the response coefficients of the past shocks and the application of the models to the estimation of the capital requirements for trading the currencies show that there are no substantial differences between the fractionally integrated models and the stable models 1998 john wiley sons ltd

accurate minimum capital risk requirements a comparison of several approaches in this paper we estimate for several investment horizons minimum capital risk requirements for short and long positions using the unconditional distribution of three daily indexes futures returns and a set of short and long memory stochastic volatility and garch type models we consider the possibility that errors follow a t student distribution in order to capture the kurtosis of the returns series the results suggest that accurate modelling of extreme observations obtained for long and short trading investment positions is possible with an autoregressive stochastic volatility model moreover modelling futures returns with a long memory stochastic volatility model produces in general excessive volatility persistence and consequently leads to large minimum capital risk requirement estimates finally the models predictive ability is assessed with the help of out of sample conditional tests

oil price dynamics and speculation a multivariate financial approach abstract this paper assesses empirically whether speculation affects oil price dynamics the growing presence of financial operators in the oil markets has led to the diffusion of trading techniques based on extrapolative expectations strategies of this kind foster feedback trading that may cause considerable departures of prices from their fundamental values we investigate this hypothesis using a modified capm following shiller 1984 and sentana and wadhwani 1992 first a univariate garch 1 1 m is estimated assuming the risk premium to be a function of the conditional oil price volatility the single factor model however is outperformed by the multifactor icapm merton 1973 which takes into account a larger investment opportunity set analysis is then carried out using a trivariate ccc garch m model with complex nonlinear conditional mean equations where oil price dynamics are associated with both stock market and exchange rate behavior we find strong evidence that oil price shifts are negatively related to stock price and exchange rate changes and that a complex web of time varying first and second order conditional moment interactions affects both the capm and feedback trading components of the model despite the difficulties we identify a significant role played by speculation in the oil market which is consistent with the observed large daily upward and downward shifts in prices a clear evidence that it is not a fundamental driven market thus from a policy point of view given the impact of volatile oil prices on global inflation and growth actions that monitor speculative activities on commodity markets more effectively are to be welcomed

linear and nonlinear dependence in turkish equity returns and its consequences for financial risk management abstract this paper investigates the dynamic behaviour of daily aggregate returns of one of europe s largest and fastest growing emerging equity markets the istanbul stock exchange ise it is found that ise returns exhibit significant linear and nonlinear dependence we investigate the nature and source of the nonlinear dependence and find that it is due primarily to linear dependence in the conditional variance of returns rather than nonlinear dependence in the conditional mean we analyse the implications of our findings for financial risk management we show that by exploiting the nonlinear dependence in ise returns the average capital required to cover against unexpected portfolio losses can be considerably reduced in contrast exploiting the linear dependence in ise returns has only a negligible impact on capital requirements

analytical pricing of discretely monitored asian style options theory and application to commodity markets we compute an analytical expression for the moment generating function of the joint random vector consisting of a spot price and its discretely monitored average for a large class of square root price dynamics this result combined with the fourier transform pricing method proposed by carr and madan carr p madan d 1999 option valuation using the fast fourier transform journal of computational finance 2 4 summer 61 73 allows us to derive a closed form formula for the fair value of discretely monitored asian style options our analysis encompasses the case of commodity price dynamics displaying mean reversion and jointly fitting a quoted futures curve and the seasonal structure of spot price volatility four tests are conducted to assess the relative performance of the pricing procedure stemming from our formulae empirical results based on natural gas data from nymex and corn data from cbot show a remarkable improvement over the main alternative techniques developed for pricing asian style options within the market standard framework of geometric brownian motion

forward and futures prices evidence from the foreign exchange markets empirical studies of the treasury bill markets have revealed substantial differences between the futures price and the implied forward price these differences have been attributed to taxes transaction costs and the settling up procedure employed in the futures market this paper examines the forward and futures prices in foreign exchange in an attempt to distinguish between the competing explanations empirical studies of the treasury bill market have revealed differences between the futures price or rate and the implicit forward price derived from the term structure of interest rates 1 these differences have generally been attributed to market imperfections such as taxes and transaction costs see for example arak 1 capozza and cornell 2 and rendelman and carabini 6 recently however cox ingersoll and ross 3 henceforth cir derived a model in which forward and futures prices need not be equal even in perfect markets without taxes as long as interest rates are stochastic the significance of the cir effect may be hard to investigate using only data from the bill market because of the potentially complicating effects of taxes and transaction costs unique to this market by using data from the foreign exchange market we are able to eliminate the tax effect and reduce the impact of transaction costs the question we address is whether the discrepancies observed in the treasury bill market are also observed in the foreign exchange market if they are then we have evidence that the differences are due to a combination of the cir effect and the transaction costs common to both markets if they are not then either the magnitude of the cir effect is much less in the foreign exchange market or the treasury bill results are due to the unique tax treatment and transaction costs of that market this paper is organized as follows in section i the trading mechanics of the forward and futures markets in foreign exchange are discussed section ii reviews the explanations for the discrepancies between the forward and futures prices for treasury bills the institutional differences between the foreign exchange and bill markets are also summarized to show which of these explanations cannot apply to the foreign exchange market in section iii the data are decribed and the empirical results are presented the conclusions are summarized in the final section

learning mixed equilibria we study learning processes for finite strategic form games in which players use the history of past play to forecast play in the current period in a generalization of fictitious play we assume only that players asymptotically choose best responses to the historical frequencies of opponents past play this implies that if the stage game strategies converge the limit is a nash equilibrium in the basic model plays seems unlikely to converge to a mixed strategy equilibrium but such convergence is natural when the stage game is perturbed in the manner of harsanyi s purification theorem journal of economic literature classification number c72

the relationship between crude oil spot and futures prices cointegration linear and nonlinear causality the present study investigates the linear and nonlinear causal linkages between daily spot and futures prices for maturities of one two three and four months of west texas intermediate wti crude oil the data cover two periods october 1991 october 1999 and november 1999 october 2007 with the latter being significantly more turbulent apart from the conventional linear granger test we apply a new nonparametric test for nonlinear causality by diks and panchenko after controlling for cointegration in addition to the traditional pairwise analysis we test for causality while correcting for the effects of the other variables to check if any of the observed causality is strictly nonlinear in nature we also examine the nonlinear causal relationships of vecm filtered residuals finally we investigate the hypothesis of nonlinear non causality after controlling for conditional heteroskedasticity in the data using a garch bekk model whilst the linear causal relationships disappear after vecm cointegration filtering nonlinear causal linkages in some cases persist even after garch filtering in both periods this indicates that spot and futures returns may exhibit asymmetric garch effects and or statistically significant higher order conditional moments moreover the results imply that if nonlinear effects are accounted for neither market leads or lags the other consistently videlicet the pattern of leads and lags changes over time

model free evaluation of directional predictability in foreign exchange markets we examine directional predictability in foreign exchange markets using a model free statistical evaluation procedure based on a sample of foreign exchange spot rates and futures prices in six major currencies we document strong evidence that the directions of foreign exchange returns are predictable not only by the past history of foreign exchange returns but also the past history of interest rate differentials suggesting that the latter can be a useful predictor of the directions of future foreign exchange rates this evidence becomes stronger when the direction of larger changes is considered we further document that despite the weak conditional mean dynamics of foreign exchange returns directional predictability can be explained by strong dependence derived from higher order conditional moments such as the volatility skewness and kurtosis of past foreign exchange returns moreover the conditional mean dynamics of interest rate differentials contributes significantly to directional predictability we also examine the co movements between two foreign exchange rates particularly the co movements of joint large changes there exists strong evidence that the directions of joint changes are predictable using past foreign exchange returns and interest rate differentials furthermore both individual currency returns and interest rate differentials are also useful in predicting the directions of joint changes several sources can explain this directional predictability of joint changes including the level and volatility of underlying currency returns copyright 2007 john wiley sons ltd