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

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

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

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

pricing options on scenario trees abstract we examine valuation procedures that can be applied to incorporate options in scenario based portfolio optimization models stochastic programming models use discrete scenarios to represent the stochastic evolution of asset prices at issue is the adoption of suitable procedures to price options on the basis of the postulated discrete distributions of asset prices so as to ensure internally consistent portfolio optimization models we adapt and implement two methods to price european options in accordance with discrete distributions represented by scenario trees and assess their performance with numerical tests we consider features of option prices that are observed in practice we find that asymmetries and or leptokurtic features in the distribution of the underlying materially affect option prices we quantify the impact of higher moments skewness and excess kurtosis on option prices we demonstrate through empirical tests using market prices of the s p500 stock index and options on the index that the proposed procedures consistently approximate the observed prices of options under different market regimes especially for deep out of the money options

approximate option valuation for arbitrary stochastic processes abstract we show how a given probability distribution can be approximated by an arbitrary distribution in terms of a series expansion involving second and higher moments this theoretical development is specialized to the problem of option valuation where the underlying security distribution if not lognormal can be approximated by a lognormally distributed random variable the resulting option price is expressed as the sum of a black scholes price plus adjustment terms which depend on the second and higher moments of the underlying security stochastic process this approach permits the impact on the option price of skewness and kurtosis of the underlying stock s distribution to be evaluated

what is fractional integration a simple construction that will be referred to as an error duration model is shown to generate fractional integration and long memory an error duration representation also exists for many familiar arma models making error duration an alternative to autoregression for explaining dynamic persistence in economic variables the results lead to a straightforward procedure for simulating fractional integration and establish a connection between fractional integration and common notions of structural change two examples show how the error duration model could account for fractional integration in aggregate employment and in asset price volatility

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

is there an energy efficiency gap many analysts have argued that energy efficiency investments offer an enormous win win opportunity to both reduce negative externalities and save money this overview paper presents a simple model of investment in energy using capital stock with two types of market failures first uninternalized externalities from energy consumption and second forces such as imperfect information that cause consumers and firms not to exploit privately profitable energy efficiency investments the model clarifies that only if the second type of market failure cannot be addressed directly through mechanisms such as information provision energy efficiency subsidies and standards may be merited this chapter therefore reviews the empirical work on the magnitude of profitable unexploited energy efficiency investments a literature which frequently does not meet modern standards for credibly estimating the net present value of energy cost savings and often leaves other benefits and costs unmeasured these problems notwithstanding recent empirical work in a variety of contexts implies that on average the magnitude of profitable unexploited investment opportunities is much smaller than engineering accounting studies suggest finally there is tremendous opportunity and need for policy relevant research that utilizes randomized controlled trials and quasi experimental techniques to estimate the returns to energy efficiency investments and the welfare effects of energy efficiency programs

a quick algorithm for pricing european average options an algorithm is described that prices european average options the algorithm is tested against monte carlo estimates and is shown to be accurate the speed of the algorithm is comparable to the black scholes algorithm a closed form solution is derived for european geometric average options

parametric inference and dynamic state recovery from option panels we develop a new parametric estimation procedure for option panels observed with error we exploit asymptotic approximations assuming an ever increasing set of option prices in the moneyness cross sectional dimension but with a fixed time span we develop consistent estimators for the parameters and the dynamic realization of the state vector governing the option price dynamics the estimators converge stably to a mixed gaussian law and we develop feasible estimators for the limiting variance we also provide semiparametric tests for the option price dynamics based on the distance between the spot volatility extracted from the options and one constructed nonparametrically from high frequency data on the underlying asset furthermore we develop new tests for the day by day model fit over specific regions of the volatility surface and for the stability of the risk neutral dynamics over time a comprehensive monte carlo study indicates that the inference procedures work well in empirically realistic settings in an empirical application to s p 500 index options guided by the new diagnostic tests we extend existing asset pricing models by allowing for a flexible dynamic relation between volatility and priced jump tail risk importantly we document that the priced jump tail risk typically responds in a more pronounced and persistent manner than volatility to large negative market shocks

general economic conditions and national elections the fact that economic conditions influence voters is a leading commonplace of conversation in election years the question is is this fact in fact a fact despite the overwhelming popularity of the fact it has received neither an explicit theoretical analysis presumably because it is so obvious that economic adversity should create political adversaries nor until recently a satisfactory statistical analysis gerald h kramer has presented a multivariate analysis of congressional elections which would strongly suggest that fluctuations in the rate of unemployment have no appreciable effect upon elections but that fluctuations in per capita real income are influential in the following pages i propose to 1 reaffirm his finding on the electoral unimportance of ordinary fluctuations in unemployment 2 argue that contrary to kramer fluctuations in real income also do not have important electoral effects and 3 present an argument based upon rational voter behavior for the unimportance of general economic conditions in national elections

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

determinants and policy implications for household electricity saving behaviour evidence from beijing china this research sets out to explore the possibilities for further saving in household electricity consumption through a study of the residents willingness and behavioural characteristics in electricity saving as applied within a chinese context based on an extensive literature review the authors argue that economic benefits policy and social norms and past experience may have a positive correlation with household electricity saving behaviour while the discomfort caused by electricity saving activities may exert a negative effect on it through a sample of 816 randomly selected residents in beijing the propositions are examined using logit regression analysis the conclusions support the ideas concerning both the positive influence of economic benefits policy and social norms and past experience as they affect broader electricity saving behaviour and the negative influence of the discomfort caused by electricity saving activities finally some inferences are drawn and suggestions are offered for policy makers and further studies

the short run and long run effects of behavioral interventions experimental evidence from energy conservation we document three remarkable features of the opower program in which social comparison based home energy reports are repeatedly mailed to more than six million households nationwide first initial reports cause high frequency action and backsliding but these cycles attenuate over time second if reports are discontinued after two years effects are relatively persistent decaying at 10 20 percent per year third consumers are slow to habituate they continue to respond to repeated treatment even after two years we show that the previous conservative assumptions about post intervention persistence had dramatically understated cost effectiveness and illustrate how empirical estimates can optimize program design jel d12 d83 l94 q41

on the efficiency of the gold options market standardized gold options were introduced on the european options exchange in 1981 in the paper we investigate the efficiency of its pricing procedures specifically the put call parity conditions are verified virtually no evidence of profitable riskless arbitrage opportunities could be found a riskless hedging strategy using the black scholes call option pricing model was used to test market efficiency and to check for consistent discrepancies between model and market prices again no evidence of market inefficiency could be found however there are indications that the black scholes model is not appropriate to price out of the money gold options an alternative option pricing model is studied which may remedy this problem

pricing european currency options a comparison of the modified black scholes model and a random variance model we use the modified black scholes model and a random variance option pricing model to study prices of european currency options traded in geneva the options which cannot be exercised early include calls and puts on the dollar swiss franc exchange rate in the empirical analysis we examine the model fit and the biases with respect to the strike price time to maturity and volatility there is some evidence of mispricing and there are small gains available by trading with the random variance model

generalized risk premia abstract this paper develops an optimal trading strategy explicitly linked to an agent s preferences and assessment of the distribution of asset returns the price of this strategy is a portfolio of implied moments and its expected excess returns naturally accommodate compensation for higher order moment risk variance risk and the equity premium approximate it to first order and it nests cross sectional asset pricing models such as the linear capital asset pricing model capm an empirical study in the us index market compares the investment behavior of an agent with recursive long run risk preferences to one who merely uses an identically independently distributed time series model and takes market prices as given the two agents exhibit very similar behavior during crises and can be distinguished mostly during calm periods

political economy of pension plans impact of institutions gender and culture abstract national pension systems are an important part of financial intermediation and worker welfare in most countries but how and why do they differ internationally controlling for important political economic and social institutions we document that international differences in pension progressivity or how pensions reflect lifetime earnings are negatively related to masculinity uncertainty avoidance individualism long term orientation employment rights average pension levels social trust and economic inequality we also find that pension progressivity is positively related to the economic and societal role of women the extent of catholicism as well as political voice and accountability these results provide important insights for both public policy and mnc managers

the risk premia embedded in index options we study the dynamic relation between aggregate stock market risks and risk premia via an exploration of the time series of equity index option surfaces the analysis is based on estimating a general parametric asset pricing model for the risk neutral equity market dynamics using a panel of options on the s p 500 index while remaining fully nonparametric about the actual evolution of market risks we nd that the risk neutral jump intensity which controls the pricing of left tail risk cannot be spanned by the market volatility and its components so an additional factor is required to account for its dynamics this tail factor has no incremental predictive power for future equity return volatility or jumps beyond what is captured by the current and past level of volatility in contrast the novel factor is critical in predicting the future market excess returns over horizons up to one year and it explains a large fraction of the future variance risk premium we contrast our ndings with those implied by structural asset pricing models that seek to rationalize the predictive power of option data relative to those studies our ndings suggest a wider wedge between the dynamics of equity market risks and the corresponding risk premia with the latter typically displaying a far more persistent reaction following market crises

optimal portfolio choice under loss aversion this paper analyzes the optimal investment strategy for loss averse investors assuming a complete market and general ito processes for the asset prices the loss averse investor follows a partial portfolio insurance strategy when the investor s planning horizon is short less than 5 years he or she considerably reduces the initial portfolio weight of stocks compared to an investor with smooth power utility the empirical section of the paper estimates the level of loss aversion implied by historical u s stock market data using a representative agent model we find that loss aversion and risk aversion cannot be disentangled empirically

split incentive effects on the adoption of technical and behavioral energy saving measures in the household sector in western europe abstract significant differences in the adoption of energy saving measures between homeowners and renters were found in the survey data of 1 248 households from the netherlands germany and belgium in this study we examined the influence of split incentive effects between homeowners and renters which stem from differences between those who pay and those who enjoy the benefits of the adoption of energy efficient ee technology and energy saving behaviors average marginal effects were used to measure the magnitude of the split incentive effect by considering many ee technologies and energy saving behaviors both split incentive effects were measured and compared for the first time producing some interesting results there is clear evidence of split incentive problems for both measures and on average homeowners were found to be16 08 more likely than renters to have access to adoptable ee technologies while the effects were much smaller only 4 28 for adopting behavioral measures the results were highly robust for household characteristics and specific psychological determinants such as willingness to pay and environmental beliefs policy implications are provided to address the split incentive problems in rental markets in household sectors based on our results

a large scale test of the effects of time discounting risk aversion loss aversion and present bias on household adoption of energy efficient technologies abstract this paper empirically and jointly analyses the relations between standard time discounting risk aversion loss aversion and present bias and household stated adoption of low to high stake energy efficiency technologies eets light emitting diodes leds energy efficient appliances and retrofit measures the analysis relies on a large representative sample drawn from eight european union countries preferences over time risk and losses were elicited and jointly estimated from participant choices in incentivized context free multiple price list experiments the findings from econometrically estimating eet adoption equations provide some support for the hypothesis that individuals who are more loss averse or more risk averse or who exhibit a lower time discount factor are less likely to have adopted eets yet some of the results significance levels and effect sizes appeared sensitive to the addition of covariates which may be an indication of bad controls finally omitting one or several of the parameters capturing preferences over time risk and losses when estimating the eet adoption equations did not appear to cause omitted variable bias

recovering risk neutral densities from option prices a new approach in this paper we present a new method of approximating the risk neutral density rnd from option prices based on the c type gram charlier series expansion gcse of a prob ability density function the exponential form of this type of gcse guarantees that it will always give positive values of the risk neutral probabilities and it can allow for stronger deviations from normality which are two drawbacks of the a type gcse used in practice to evaluate the performance of the suggested expansion of the rnd the paper presents simulation and empirical evidence

a nonlinear factor analysis of s p 500 index option returns growing evidence suggests that extraordinary average returns may be obtained by trading equity index options and that at least part of this abnormal performance is attributable to volatility and jump risk premia this paper asks whether such priced risk factors are alone sufficient to explain these average returns to provide an answer in as general as possible a setting i estimate a flexible class of nonlinear models using all s p 500 index futures options traded between 1986 and 2000 the results show that priced factors contribute to these expected returns but are insufficient to explain their magnitudes particularly for short term out of the money puts in a recent paper c oval and shumway 2001 examine the returns on deltahedged option positions focusing on the at the money straddle and find average returns close to minus 3 per week since over short time horizons these positions are approximately invariant to movements in the underlying index coval and shumway argue that their capm betas should be near zero and their expected returns close to the risk free rate they conclude that large deviations from the capm are the norm which they suggest is evidence that some other systematic factor such as stochastic volatility might be priced by the market similar conclusions are made by jackwerth 2000 who finds risk adjusted profitability from selling puts and by bakshi and kapadia 2003 who find that the volatility risk premium contributes significantly to higher prices for calls and puts buraschi and jackwerth 2001 concur suggesting that more than one priced risk factor is necessary to explain option prices a less direct set of evidence is the now standard observation that the black scholes implied volatilities of equity index options are upward biased predictors of future realized volatility numerous studies such as fleming ostdiek and whaley 1995 and christensen and prabhala 1998 document that implied volatilities of short term at the money equity index options are on average several percentage points higher than the volatilities realized over the option s

inferring volatility dynamics and risk premia from the s p 500 and vix markets abstract we estimate a flexible affine model using an unbalanced panel containing s p 500 and vix index returns and option prices and analyze the contribution of vix options to the model s in and out of sample performance we find that they contain valuable information on the risk neutral conditional distributions of volatility at different time horizons which is not spanned by the s p 500 market this information allows enhanced estimation of the variance risk premium we gain new insights on the term structure of the variance risk premium present a trading strategy exploiting these insights and show how to improve s p 500 return forecasts

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

the factor structure in equity options principal component analysis of equity options on dow jones rms reveals a strong factor structure the rst principal component explains 77 of the variation in the equity volatility level 77 of the variation in the equity option skew and 60 of the implied volatility term structure across equities furthermore the rst principal component has a 92 correlation with sp g12 g13

financial contagion and asset pricing abstract asset market interconnectedness can give rise to significant contagion risks during periods of financial crises that extend beyond the risks associated with changes in volatilities and correlations these channels include the transmission of shocks operating through changes in the higher order comoments of asset returns including changes in coskewness arising from changes in the interaction between volatility and average returns across asset markets these additional contagion channels have nontrivial implications for the pricing of options through changes in the payoff probability structure and more generally in the management of financial risks the effects of incorrectly pricing risk has proved to be significant during many financial crises including the subprime crisis from mid 2007 to mid 2008 the great recession beginning 2008 and the european debt crisis from 2010 using an exchange options model the effects of changes in the comoments of asset returns across asset markets are investigated with special emphasis given to understanding the effects on hedging risk during financial crises the results reveal that by not correctly pricing the risks arising from higher order moments during financial crises there is significant mispricing of options while hedged portfolios during noncrisis periods become exposed to price movements in times of crises

estimation methods for stochastic volatility models a survey abstract although stochastic volatility sv models have an intuitive appeal their empirical application has been limited mainly due to difficulties involved in their estimation the main problem is that the likelihood function is hard to evaluate however recently several new estimation methods have been introduced and the literature on sv models has grown substantially in this article we review this literature we describe the main estimators of the parameters and the underlying volatilities focusing on their advantages and limitations both from the theoretical and empirical point of view we complete the survey with an application of the most important procedures to the s p 500 stock price index

uncertainty in electricity markets from a semi nonparametric approach abstract this paper introduces a semi nonparametric snp methodology for the modeling of skewness leptokurtosis and high order moments in electricity markets we highlight the importance of accurately measuring these features in many contexts e g design of power plants with different technologies fuel prices and energy demand and the need for using flexible non normal densities we show that the snp approach describes the uncertainty in an electricity markets reducing the limitations that normality and parametric density functions impose our application covers a wide variety of colombian electricity variables including spot price national energy demand the climate index oni and the series of hydrologic inflows for different rivers for such variables we find that the snp outperforms the normal distribution in terms of accuracy measures based on maximum likelihood estimation as a result our methodology has direct applications for risk analysis and portfolio choice related to electricity markets and for implementing policies on electricity markets that improve efficiency and sustainability

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

the jump component of s p 500 volatility and the vix index much research has investigated the differences between option implied volatilities and econometric model based forecasts implied volatility is a market determined forecast in contrast to model based forecasts that employ some degree of smoothing of past volatility to generate forecasts implied volatility has the potential to reflect information that a model based forecast could not this paper considers two issues relating to the informational content of the s p 500 vix implied volatility index first whether it subsumes information on how historical jump activity contributed to the price volatility followed by whether the vix reflects any incremental information pertaining to future jump activity relative to model based forecasts it is found that the vix index both subsumes information relating to past jump contributions to total volatility and reflects incremental information pertaining to future jump activity this issue has not been examined previously and expands our understanding of how option markets form their volatility forecasts

stars and standards energy efficiency in rental markets abstract evidence suggests that rental properties are often associated with lower levels of energy efficiency than owner occupied buildings policy makers are increasingly concerned about this energy efficiency gap in this paper we investigate the energy investments made and the market efficiency gains associated with different policy interventions at the point of lease we introduce key features of the housing rental market in the laboratory and examine four policy options mandatory information on energy efficiency voluntary information mandatory minimum standards and a cost share treatment i e landlords pay a share of the tenants energy bill we find that enabling landlords to post the energy efficiency of their properties increases investment in energy efficiency voluntary information achieves efficiency levels comparable to those under a mandatory programme but may lead to lower levels of tenant participation mandatory minimum standards lead to higher investments in energy efficiency but also reduce the number of properties available for lease cost sharing leads to low market efficiency levels perhaps due to the uncertainty landlords face regarding the energy bill of their tenants

small dimension pde for discrete asian options abstract this paper presents an efficient method for pricing discrete asian options in presence of smile and non proportional dividends using an homogeneity property we show how to reduce an n 0 dimensional problem to a one or two dimensional one we examine different numerical specifications of our dimension reduced pde using a crank nicholson method interpolation method grid boundaries time and space steps as well as the extension to the case of non proportional discrete dividends using a jump condition we benchmark our results with quasi monte carlo simulation and a multi dimensional pde

analysis of the term structure of implied volatilities from various empirical work it is well known that the volatility of asset returns changes over time this might be one of the reasons that implied volatilities differ for options that only differ in time to maturity we construct models for the relation between short and long term implied volatilities based on three different assumptions of stock return volatility behavior i e mean reverting garch and egarch models we test these relations on option price data and conclude that egarch gives the best description of asset prices and the term structure of options implied volatilities

household energy elasticities and policy implications for pakistan abstract this study estimates fuel expenditure and price elasticities of household fuels in pakistan the burning of biomass is harmful to health and the environment and may cause preventable morbidity and mortality it is important to investigate how households fuel choices are linked to prices so that governments can consider appropriate steps to enhance the consumption of clean fuels using three pooled cross sectional surveys from pakistan and applying the linear approximate almost ideal demand system la aids model we found that all fuel types except natural gas were price inelastic at the national level and for urban households in rural areas natural gas and lpg were found to be more price elastic compared to urban areas simple policy simulations based on our results suggest that in order to reduce indoor air pollution by encouraging the adoption of clean fuels lpg and piped natural gas governments should subsidies clean fuels rather than imposing taxes on solid fuels moreover in the case of pakistan a subsidy for lpg should be preferred over a subsidy for piped natural gas as it produces a more cost effective reduction in solid fuel use

a study of diffusion processes for foreign exchange rates abstract the nature of the stochastic process generating the time path of foreign exchange rates plays an important role in dynamic theories of international financial economics an important consideration in this stochastic process is the relationship between currency return variances and exchange rate levels using five years of daily data separated into quarterly intervals this study demonstrates that currency return variances depend on exchange rate levels and the dependency is unstable intertemporally thus these empirical results contradict the assumption of stable log normal distribution and the more general assumption of constant elasticities of variances for elasticity coefficients ordinary least squares estimates are compared to maximum likelihood estimates the maximum likelihood estimator clearly is superior implications of these results for models of foreign exchange rates are discussed

estimating the parameters of stochastic volatility models using option price data this article describes a maximum likelihood method for estimating the parameters of the standard square root stochastic volatility model and a variant of the model that includes jumps in equity prices the model is fitted to data on the s p 500 index and the prices of vanilla options written on the index for the period 1990 to 2011 the method is able to estimate both the parameters of the physical measure associated with the index and the parameters of the risk neutral measure associated with the options including the volatility and jump risk premia the estimation is implemented using a particle filter whose efficacy is demonstrated under simulation the computational load of this estimation method which previously has been prohibitive is managed by the effective use of parallel computing using graphics processing units gpus the empirical results indicate that the parameters of the models are reliably estimated and consistent with values reported in previous work in particular both the vola

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

peasants or bankers the american electorate and the u s economy t he usual model of electoral reaction to economic conditions assumes the retrospective economic voter who bases expectations solely on recent economic performance or personal economic experience voter as peasant a second model assumes a sophisticated economic voter who incorporates new information about the future into personal economic expectations voter as banker using the components both retrospective and prospective of the index of consumer sentiment ics as intervening variables between economic conditions and approval we find that the prospective component fully accounts for the presidential approval time series with aggregate consumer expectations about long term business conditions in the approval equation neither the usual economic indicators not the other ics components matter moreover short term changes in consumer expectations respond more to current forecasts than to the current economy the qualitative result is a rational expectations outcome the electorate anticipates the economic future and rewards or punishes the president for economic events before they happen economics moves political behavior with hard times administrations lose support with good times they gain it we know this to be true but when we ask how by what processes the political translation of economic experience occurs the an

gender interactions within hierarchies evidence from the political arena this paper studies gender interactions within hierarchical organizations using a large data set on the duration of italian municipal governments elected between 1993 and 2003 a municipal government can be viewed as a hierarchy whose stability over time depends on the degree of cooperation between and within ranks we find that in municipalities headed by female mayors the probability of early termination of the legislature is higher this result persists and becomes stronger when we control for municipality fixed effects as well as for non random sorting of women into municipalities using regression discontinuity in gender mixed electoral races decided by a narrow margin the likelihood that a female mayor survives until the end of her term is lowest when the council is entirely male and in regions with less favourable attitudes towards working women this evidence is suggestive that group dynamics are an important factor in driving the gender difference other interpretations receive less support in the data our results may provide an alternative explanation for the underrepresentation of women in leadership positions

the price of the smile and variance risk premia using a new specification of multifactor volatility we estimate the hidden risk factors spanning s p 500 index spx implied volatility surfaces and the risk premia of volatility sensitive payoffs

tails fears and risk premia we show that the compensation for rare events accounts for a large fraction of the average equity and variance risk premia exploiting the special structure of the jump tails and the pricing thereof we identify and estimate a new investor fears index the index reveals large time varying compensation for fears of disasters our empirical investigations involve new extreme value theory approximations and high frequency intraday data for estimating the expected jump tails under the statistical probability measure and short maturity out of the money options and new model free implied variation measures for estimating the corresponding risk neutral expectations

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

the dynamics of the partisan gender gap genderdifferencesinvotechoice opinion andpartyidentificationhavebecomeacommonfeature of the american political landscape we examine the nature and causes of gender differences in partisanship using a time series approach we show that gender differences are pervasive existing outside of the context of specific elections or issues and that they are a product of the interaction ofsocietalconditionsandpolitics wefindthatfrom1979to2000 thepartisangendergaphasgrownwhen the political climate moved in a conservative direction the economy deteriorated and the percentage of economically vulnerable single women increased the gender gap is likely to be a continual feature of the american political landscape one that shapes everything from elite political behavior to election outcomes t he partisan preferences of men and women have both converged and diverged at different times in history the late 1970s for example saw a period in which men and women shared similar levels of democratic and republican partisan support since the early 1980s however partisan preferences have diverged the divergences are fundamentally political oftendecidingelectionoutcomes helpingstructure policy debates and election campaigns and also contributing to policy outcomes each of these may in turn either fuel or diminish the original differences in the partisanship of men and women and lead to a politics more or less divided on the basis of gender politicians for example may be well served by reaching out and supporting issues designed to minimize differences in support from men and women especially when the parties find themselves in rough parity electoral motivations may also lead politicians to support policy that exacerbatesgenderdifferenceswhengapsworkintheir favor further contributing to them to the extent that partisandifferencesacrossgendersarepersistent these implications become more profound characterizing thepoliticallandscapeforlongperiodsoftime convergence in the partisan preferences of men and women

short term market risks implied by weekly options we study short maturity weekly s p 500 index options which provide a direct way to analyze volatility and jump risks unlike longer dated options they are largely insensitive to the risk of intertemporal shifts in the economic environment adopting a novel seminonparametric approach we uncover variation in the negative jump tail risk which is not spanned by market volatility and helps predict future equity returns as such our approach allows for easy identification of periods of heightened concerns about negative tail events that are not always signaled by the level of market volatility and elude standard asset pricing models

willingness to pay for energy saving measures in residential buildings this paper uses a choice experiment to evaluate the consumers willingness to pay for energy saving measures in switzerland s residential buildings these measures include air renewal ventilation systems and insulation of windows and facades two groups of respondents consisting respectively of 163 apartment tenants and 142 house owners were asked to choose between their housing status quo and each one of the several hypothetical situations with different attributes and prices the estimation method is based on a fixed effects logit model the results suggest that the benefits of the energy saving attributes are significantly valued by the consumers these benefits include both individual energy savings and environmental benefits as well as comfort benefits namely thermal comfort air quality and noise protection

the split incentives energy efficiency problem evidence of underinvestment by landlords abstract due to asymmetric information between landlords and renters landlords with tenants who pay the utility bill underinvest in energy efficiency measures using data from the 2009 residential energy consumption survey i present empirical evidence that this underinvestment occurs in multiple categories of residential energy efficiency space heating water heating window thickness insulation and weatherization because these landlords did not invest at the same rate as homeowners and landlords who pay the energy bill their tenants energy bill was higher by nearly 2 when combined with other researchers estimations for appliances davis 2010 insulation and thermostat responsiveness for tenants gillingham et al 2012 our results imply that renters use approximately 2 7 more energy overall due to the landlord tenant split incentive issue

the simulation of option prices with application to liffe options on futures we build a framework for modelling the deviation of observed option prices from the black scholes prices we use a flexible model for a density a two sided switching weibull to capture the implied volatility the model can be used to generate prices it can take into account no arbitrage bounds for option prices and is capable of generating such stylised facts as the smile effect we apply this methodology to liffe options on german government bond futures

volatility related exchange traded assets an econometric investigation we develop a theoretical framework for covariance stationary but persistent positively valued processes which combines a semi nonparametric expansion of the gamma distribution with a component version of the multiplicative error model our conditional mean assumption allows for slow possibly nonmonotonic mean reversion while our distribution assumption provides more flexibility than a traditional laguerre expansion while preserving positivity of the density we apply our framework to a dynamic portfolio allocation for exchange traded notes tracking short and mid term vix futures indices which are increasingly popular but risky financial instruments we show the superior performance of the strategies based on our econometric model

a non structural investigation of vix risk neutral density abstract we propose a non structural method to retrieve the risk neutral density rnd implied by options on the cboe volatility index vix the methodology is based on orthogonal polynomial expansions around a kernel density and yields the rnd of the underlying asset without the need for a parametric specification the classic family of laguerre expansions is extended to include the gig and the generalized weibull kernels we show that orthogonal polynomial expansions yield accurate approximations of the rnd of vix and they generally outperform commonly used non parametric methods when controlling for accuracy based on a panel of observed vix options we retrieve the variance swap term structure the time series of vvix the vix risk neutral moments and the volatility at risk which reveal a number of stylized facts on the rnd of vix

modeling and predicting the cboe market volatility index abstract this paper performs a thorough statistical examination of the time series properties of the daily market volatility index vix from the chicago board options exchange cboe the motivation lies not only on the widespread consensus that the vix is a barometer of the overall market sentiment as to what concerns investors risk appetite but also on the fact that there are many trading strategies that rely on the vix index for hedging and speculative purposes preliminary analysis suggests that the vix index displays long range dependence this is well in line with the strong empirical evidence in the literature supporting long memory in both options implied and realized variances we thus resort to both parametric and semiparametric heterogeneous autoregressive har processes for modeling and forecasting purposes our main findings are as follows first we confirm the evidence in the literature that there is a negative relationship between the vix index and the s p 500 index return as well as a positive contemporaneous link with the volume of the s p 500 index second the term spread has a slightly negative long run impact in the vix index when possible multicollinearity and endogeneity are controlled for finally we cannot reject the linearity of the above relationships neither in sample nor out of sample as for the latter we actually show that it is pretty hard to beat the pure har process because of the very persistent nature of the vix index

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

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

the pricing of tail risk and the equity premium evidence from international option markets we explore the pricing of tail risk as manifest in index options across international equity markets the risk premium associated with negative tail events displays persistent shifts unrelated to

unspanned stochastic volatility in affine models evidence from eurodollar futures and options unspanned stochastic volatility usv refers to the inability of bonds to replicate volatility sensitive derivative securities affine term structure models require special restrictions on the parameters to exhibit usv we use a joint eurodollar futures and options data set to estimate affine three factor models with and without usv restrictions the unrestricted model captures prices of futures and options well option pricing errors are much larger in the usv model the usv model is rejected in favor of the unrestricted model based on the likelihood ratio and wald tests we use the implications of the unrestricted model as a benchmark for understanding the extant evidence that favors usv specifically we replicate extant tests in samples simulated from the unrestricted model we show that none of the existing findings contradict the model without usv restrictions

the dynamics of aggregate partisanship despite extensive research on party identification links between partisanship at the individual and aggregate level have largely been ignored this leaves a gap in our understanding of the dynamics of aggregate partisanship to remedy this we identify a set of ideal types that capture the essential arguments made about individual level party identification we then combine the behavioral assumptions for each type with existing results on statistical aggregation to deduce the specific temporal pattern that each type implies for aggregate levels of partisanship using new diagnostic tests and a highly general time series model we find that aggregate measures of partisanship from 1953 through 1992 are fractionally integrated our evidence that the effects of a shock to aggregate partisanship last for years not months or decades challenges previous work by party systems theorists and students of macropartisanship our arguments and empirical evidence provide a conceptually richer and more precise basis for theories of issue evolution or endogenous preferences in which partisanship plays a central role

good volatility bad volatility and option pricing advances in variance analysis permit the splitting of the total quadratic variation of a jump diffusion process into upside and downside components recent studies establish that this decomposition enhances volatility predictions and highlight the upside downside variance spread as a driver of the asymmetry in stock price distributions to appraise the economic gain of this decomposition we design a new and flexible option pricing model in which the underlying asset price exhibits distinct upside and downside semivariance dynamics driven by the model free proxies of the variances the new model outperforms common benchmarks especially the alternative that splits the quadratic variation into diffusive and jump components

the economics of options implied inflation probability density functions recently a market in options based on cpi in ation in ation caps and oors has emerged in the us this paper uses quotes on these derivatives to construct probability densities for in ation we study how these pdfs respond to news announcements and nd that the implied odds of de ation are sensitive to certain macroeconomic news releases we compare the option implied probability densities with those obtained by time series methods and use this information to construct empirical pricing kernels the options implied densities assign considerably more mass to extreme in ation outcomes either de ation or high in ation than do their time series counterparts this yields a u shaped empirical pricing kernel with investors having high marginal utility in states of the world characterized by either de ation or high in ation

option pricing and implicit volatilities abstract this paper demonstrates that black scholes implied volatilities can be used to value options in many situations where the assumptions of the black scholes model are violated including i alternative stock processes ii stochastic interest rates and iii market frictions given its computational simplicity this procedure provides an attractive alternative to the more complex models with a direct estimation procedure

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

integrated dynamic models for hedging international portfolio risks abstract we develop scenario based stochastic programming models for hedging the risks of international portfolios using options the models provide increasing level of integration in managing market and foreign exchange fx risks we start with a single stage model with currency options for selective hedging of fx risks while market risk is addressed through diversification we add stock options to hedge market risks and add quantos and currency options to develop an integrated model using an innovative method to price quantos on the scenario tree underpinning the stochastic program the models are extended to multi stage settings backtesting on market data over a 14 year period that includes the global financial crisis of 2008 we demonstrate the effectiveness of taking increasingly integrated views of risk management simultaneous hedging of market and fx risks using stock and currency options has the best ex post performance the differences are economically significant and statistical significance is established through rigorous hypothesis testing the models are particularly effective during the crisis test results show that two stage models outperform their single stage counterparts regardless of the hedging strategy

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