hedging with options under variance uncertainty an illustration of pricing new crop soybeans the behavior of a commodity s price return variance over time is critical to both the theory and practice of commodity option valuation in this paper three models are used to forecast soybean price variance for the period during which a seasonal increase in variance has been found in previous studies a time series model outperforms the ordinary least squares and naive models the significance of the forecast error levels is then examined in terms of expected deviations above and below a price target for a put hedge the resulting trade off between risk and return is shown by strike price and variance expectation

the optimal mechanism for selling to a budget constrained buyer abstract this paper finds an optimal mechanism for selling a good to a buyer who may be budget constrained we consider a seller with one unit of a good facing a buyer with a quasilinear utility function if the buyer does not face a binding budget constraint textbook monopoly pricing is optimal by contrast the possibility of a binding budget constraint can make it optimal for the seller to use nonlinear pricing to commit to a declining price sequence to require the buyer to disclose his budget or to offer financing journal of economic literature classification numbers c70 d42 d45 d89 l12

limit order submission strategies under asymmetric information abstract this paper provides evidence that informed traders dominate the response of limit order submissions to shocks in a pure limit order market in the market we study informed traders are highly sensitive to spreads volatility momentum and depth by contrast uninformed traders are relatively insensitive to all these market conditions the dominance of the informed over limit order submissions is magnified by contrasts between them and the uninformed in the use of aggressively priced limit orders

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

does the bund dominate price discovery in euro bond futures examining information shares abstract this paper examines the relative information shares of the bund i e the 10 year euro bond future contract on german sovereign debt versus two futures with shorter maturity we find that the bund is most important but does not dominate price discovery the other contracts also have relevant and at many days even higher information shares in examining determinants of information shares we add order flow measures to market state variables and macroeconomic news more order flow in a contract consistently increases this contract s information share

limit order book as a market for liquidity we develop a dynamic model of an order driven market populated by discretionary liquidity traders these traders must trade yet can choose the type of order and are fully strategic in their decision traders differ by their impatience less patient traders demand liquidity more patient traders provide it three equilibrium patterns are obtained the pattern is determined by three parameters the degree of impatience of the patient traders which we model as the cost of execution delay in providing liquidity their proportion in the population which determines the degree of competition among the liquidity providers and the tick size which is the cost of the minimal price improvement despite its simplicity the model generates a rich set of empirical predictions on the relation between market parameters time to execution and spreads we argue that the economic intuition of this model is so basic its main results must be robust in much more general models

dynamic procurement under uncertainty optimal design and implications for incomplete contracts we characterize the optimal dynamic contract for a long term basic service when an uncertain add on is required later on introducing firm risk aversion has two impacts profits for the basic service can be backloaded to induce cheaper information revelation for this service an income effect which reduces output distortions the firm must also bear some risk to induce information revelation for the add on this risk effect reduces the level of the add on but hardens information revelation for the basic service the interaction between these effects has important implications for the dynamics of distortions contract renegotiation and the value of incomplete contracts

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

tests of the foreign exchange risk premium using the expected second moments implied by option pricing abstract this paper utilizes the second moment expectations implied by currency option pricing to demonstrate that these expectations are systematically related to expected return differentials across assets denominated in different currencies because the measured deviations from uncovered interest rate parity are tied to variables which theory links to the risk premium the results provide substantial evidence that a risk premium does indeed exist as opposed to the alternative of a violation of rational expectations however like previous attempts the data do not support an explicit mean variance formulation of the risk premium

appropriate design of auctions for renewable energy support prequalifications and penalties abstract auctions are a promising tool to accomplish renewable energy support res however they involve diverse risks for the auctioneer and the bidders the major risk for the auctioneer with respect to the expansion target and the acceptance of auctions for res in general is the risk of non realization awarded bidders do not realize their projects the main reasons are bidders uncertainties concerning their project costs the auctioneer can reduce the non realization risk by taking various measures the most discussed and implemented measures are financial and physical prequalifications and penalties an evaluation of these measures has relevant implications for an appropriate auctions design for res the non realization option induces lower bids a suitable combination of financial and physical prequalifications can reduce the non realization risk significantly however involves sunk costs counterintuitively first price auction and second price auction lead to different expected award prices and different realization probabilities penalties bear a high risk of inefficient auction outcomes the appropriate parametrization and combination of the measures is challenging under consideration of all implications we recommend high financial and adjusted physical prequalifications to achieve a sufficiently high realization rate while maintaining efficiency

an empirical test of a valuation model for american options on futures contracts pricing models for american call and put options on futures contracts are derived herein these models are used to investigate the efficiency of the market for options on standard poor 500 and german mark futures the evidence presented here indicates that market prices for these options deviate substantially from their corresponding model prices in addition it is shown that a hedging strategy originated at prices that indicate a deviation of market from model is successful in translating the observed mispricing into excess profits after transactions costs however these net profits are eliminated if the origination of the strategy is delayed by one trade or if bid ask spreads are accounted for

pricing and trading european options by combining artificial neural networks and parametric models with implied parameters we compare the ability of the parametric black and scholes corrado and su models and artificial neural networks to price european call options on the s p 500 using daily data for the period january 1998 to august 2001 we use several historical and implied parameter measures beyond the standard neural networks in our analysis we include hybrid networks that incorporate information from the parametric models our results are significant and differ from previous literature we show that the black and scholes based hybrid artificial neural network models outperform the standard neural networks and the parametric ones we also investigate the economic significance of the best models using trading strategies extended with the chen and johnson modified hedging approach we find that there exist profitable opportunities even in the presence of transaction costs

arbitrage continuous trading and margin requirements this paper studies the impact that margin requirements have on both the existence of arbitrage opportunities and the valuation of call options in the context of the blackscholes economy margin restrictions are shown to exclude continuous trading arbitrage opportunities and with two additional hypotheses still to allow the black scholes call model to apply the black scholes economy consists of a continuously traded stock with a price process that follows a geometric brownian motion and a continuously traded bond with a price process that is deterministic continuous trading security market models constitute a significant area of continuing reesearch in financial economics these models form the basis of the option pricing methodology see merton 16 for a review and current intertemporal asset pricing models see merton 15 breeden 3 and cox ingersoll and ross 5 given the importance of these models it is of no surprise that there has been significant academic concern see dybvig 9 cox ingersoll and ross 4 p 341 and ingersoll 13 pp 13 25 over the discovery of a continuous trading strategy by harrison and kreps 10 called the doubling strategy that generates a sure dollar from a zero investment the existence of this doubling strategy violates a basic premise of the option pricing methodology the premise of no arbitrage opportunities given this violation the question naturally arises as to whether the option pricing methodology is internally consistent fortunately harrison and pliska 11 showed that the exclusion of arbitrage opportunities and the doubling strategy does not invalidate the familiar derivation of the black scholes call option formula the exogenous exclusion of these doubling strategies is somewhat arbitrary however types of constraints that exclude continuous trading arbitrage opportunities were studied by kreps 14 harrison and kreps 10 and dybvig 9 these papers provide constraints that are unsatisfactory from an institutional point of view since they have no market analogue margin requirements on the other hand have a market analogue one purpose of this paper is to show that margin requirements also exclude continuous trading arbitrage opportunities to make this argument self contained we first provide a unified framework that synthesizes the previously stated results our assertion concerning margin re

so what orders do informed traders use we present a simple glosten milgrom type equilibrium model to analyze the decision of informed traders on whether to use limit or market orders we show that even after incorporating an order s price impact not only may informed traders prefer to use limit orders but the probability that they submit limit orders can be so high that limit orders convey more information than market orders we further show that the horizon of the private information is critical for this decision and is positively related to the use of limit orders our empirical analysis using torq suggests that informed traders do prefer limit orders to market orders and that limit orders are indeed more informative our model is in contrast to the literature that assumes that informed traders use market orders only and the literature that examines the limit order versus the market order decision of uninformed traders

can information heterogeneity explain the exchange rate determination puzzle empirical evidence shows that most exchange rate volatility at short to medium horizons is related to order flow and not to macroeconomic variables we introduce symmetric information dispersion about future macroeconomic fundamentals in a dynamic rational expectations model in order to explain these stylized facts consistent with the evidence the model implies that a observed fundamentals account for little of exchange rate volatility in the short to medium run b over long horizons the exchange rate is closely related to observed fundamentals c exchange rate changes are a weak predictor of future fundamentals and d the exchange rate is closely related to order flow

the effects of trade size and market depth on immediate price impact in a limit order book market abstract we compare trade size to the prevailing market depth at the best level in the limit order book to detect and account for zero impact trades in an immediate price impact model our model also incorporates standard trade attributes trade size market capitalization and volatility in a dynamic setting the incorporation of market depth information reduces the mean absolute squared forecast error of an immediate price impact prediction by about 60 after controlling for trade attributes market depth price impact dynamics and intra and inter day periodicities in order of relative importance all improve the prediction of a trade s price impact we demonstrate the value of our model by showing that splitting a big order into a series of smaller trades results in a reduction of between 60 and 82 of the immediate price impact cost of the big order we also find that our depth indicator helps with the prediction of order flow and permanent price impact

credit auctions and bid caps abstract in this paper we offer two contributions to the field of credit auctions first we compare first and second price credit auctions and provide solvency dependent conditions such that one mechanism dominates the other in terms of expected payoffs of all the parties involved in addition we present a new possibility of using bid caps in credit auctions we study the equilibria in the capped mechanisms and show that bid caps can increase the seller s expected payoff and in some cases the expected payoffs of all sides a win win situation

pricing hang seng index options around the asian financial crisis a garch approach abstract this paper investigates how well the hang seng index options the most important class of option contracts traded in hong kong are priced using the garch approach we calibrated the garch parameters using the call and put option data and used them to price options in the subsequent weeks we found the garch model performs very well in comparison with the black scholes model even after allowing for a smile smirk adjustment its superior performance was also evident both before and during the recent asian financial turmoil

trader rationality in the exercise of futures options abstract we examine the rationality of investor exercise behavior by analyzing two years tendered exercise notices for treasury bond futures options we conclude that exercise behavior is generally rational but document numerous failures to exercise as well as some exercises that should not have occured both at and prior to expiration the most frequent type of error is failing to exercise suggesting that traders do not monitor their positions with sufficient care finally we show that investors use information arriving after trading closes but before exchange imposed exercise deadlines in forming their exercise decisions

optimal bidding in auctions from a game theory perspective abstract the game theoretic perspective in auction bidding has provided a powerful normative framework for the analysis of auctions and it has generated an impressive volume of research contributions tracing this research we review key recent advances which have greatly expanded our understanding of the operation of auctions and produced a more accurate analysis of mechanism design and optimal bidding we follow various experimental studies which have shown that the predictive power of auction theory remains in many cases limited for this reason we concentrate on research themes which enhance the applicability of auction theory leading to more realistic descriptions of bidding behaviors we identify important innovations which expand the environment of auction bidding and carry us beyond rational decision making we conclude providing directions of future research and discussing their implications

the effects of transaction costs and different borrowing and lending rates on the option pricing model a note this paper modifies the black scholes option pricing model to include the effects of transaction costs and different borrowing and lending rates the paper demonstrates that these market imperfections tend to offset each other yielding a bounded range of prices for each option the paper also shows that under some conditions the option pricing hedge may be society s lowest cost financial intermediary

the pricing of convexity risk and timedecay in options markets abstract option valuation formulas typically assume all risk can be eliminated in a continuously rebalanced hedge but convexity of the option pricing function and time decay cause risk in real world hedges we find strong evidence in stock options transactions data from periods 10 years apart that the market prices these risks there is a significant price effect associated with convexity that becomes larger immediately following a period of larger stock price movements although time decay is highly correlated with convexity a multiple regression including both factors shows it to have a significant independent effect the results from the two sample periods are highly consistent as are pre and post crash results from the year 1987

decomposing liquidity along the limit order book abstract in this paper we estimate the asymmetric information and order processing components of liquidity at extended depths along the limit order book using data from the inet ecn we find that the asymmetric information component decreases as depth increases inactive stocks have more information asymmetry at the inside quotes but it decreases more rapidly along the book than for active stocks the order processing component of liquidity has fixed and variable constituents consistent with a fixed cost per order as well as a variable portion based on the size of the order

the weekend effect on the distribution of stock prices abstract evidence of weekend effects on the distribution of security returns suggests that returns are generated by a process operating closer to trading time rather than calendar time in contrast accumulation of interest over the weekend follows a calendar time process since both the variance of returns and the interest rate are important parameters of the black scholes option pricing model this paper suggests that the model be stated to account for this by utilizing a trading time variance and a calendar time interest rate empirical evidence indicates that this allows the model to better explain market option prices

hedging the risks from writing foreign currency options abstract this paper considers the ways in which banks and other financial institutions can hedge their risks when they write non exchange traded foreign currency options key factors affecting the performance of delta hedging are identified and hedging schemes involving the use of exchange traded options are analyzed the schemes are tested using both simulated data and data from trades on the philadelphia exchange between february 1983 and september 1984

order submission strategy and the curious case of marketable limit orders we provide empirical evidence on order submission strategy of investors with similar commitments to trade by comparing the execution costs of market orders and marketable limit orders i e limit orders with the same trading priority as market orders the results indicate the unconditional trading costs of marketable limit orders are significantly greater than market orders we attribute the difference in costs to a selection bias and provide evidence suggesting the order submission strategy decision is based on prevailing market conditions and stock characteristics after correcting for the selection bias the results show the average trader chooses the order type with lower conditional trading costs

the measurement of option mispricing abstract different studies have examined the ability of the black scholes option pricing model to estimate accurately market prices of publicly traded options and reached conflicting results this study examines commonly used ex ante measures of option mispricing finds that they can produce differing conclusions about option prices and develops an alternative measure for gauging option mispricing empirical analysis of returns to options selected using the various mispricing measures indicates that this new measure is more likely to detect mispricing and identify options that yield excess returns before commissions

segmentation and time of day patterns in foreign exchange markets abstract this paper sheds light on a puzzling pattern in spot foreign exchange markets domestic currencies appreciate depreciate systematically during foreign domestic working hours this phenomenon spans many years and several exchange rates and overrides calendar effects we argue that it is mainly due to liquidity and inventory patterns that emerge from the combination of two factors domestic agents tend to be net buyers of foreign currency and to trade mostly in their country s working hours the prevalence of domestic foreign traders demanding the counterpart currency during domestic foreign working hours implies sell price buy price pressure on the domestic currency during domestic foreign working hours

comparative performance of the black scholes and roll geske whaley option pricing models the original black scholes bs 2 european call option pricing model does not take account of divided payments on the underlying stock and does not allow for the possibility of early exercise that may be optimal when the stock pays dividends black 1 has suggested that the original bs model can be modified to take account of dividends and sharpe 14 predicts that this modified or pseudo american bs approach while not exact is probably sufficient for many listed options

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

limit orders depth and volatility evidence from the stock exchange of hong kong we investigate the role of limit orders in the liquidity provision in a pure orderdriven market results show that market depth rises subsequent to an increase in transitory volatility and transitory volatility declines subsequent to an increase in market depth we also examine how transitory volatility affects the mix between limit orders and market orders when transitory volatility arises from the ask bid side investors will submit more limit sell buy orders than market sell buy orders this result is consistent with the existence of limit order traders who enter the market and place orders when liquidity is needed

the relative performance of five alternative warrant pricing models five warrant pricing models are examined in this study a pair based on the black scholes model a pair based on the constant elasticity of variance cev modification and an extendible warrant model a la longstaff based on more than 20 000 warrant price observations the flexible exponent cev model generates the lowest average absolute pricing error in most of the warrants examined the dilution adjusted black scholes model however remains a reasonable economical alternative in many cases

the behavior of the volatility implicit in the prices of stock index options abstract we examine stock market volatility around the quarterly expirations of stock index futures contracts and nonquarterly expirations of stock index options using estimates of the volatility implicit in the option prices the option prices reflect increases in the volatility of the underlying stock indexes around both quarterly and nonquarterly expiration dates analysis of the residual returns on index options provides evidence consistent with an unexpected increase in market volatility around expiration dates

the costs and determinants of order aggressiveness abstract this paper examines the costs and determinants of order aggressiveness aggressive orders have larger price impacts but smaller opportunity costs than passive orders price impacts are amplified by large orders small firms and volatile stock prices to minimize the implementation shortfall the optimal strategy is to enter buy sell orders at the bid ask aggressive buy sell orders tend to follow other aggressive buy sell orders and occur when bid ask spreads are narrow and depth on the same opposite side of the limit book is large small aggressive buys are more likely than sells to be motivated by information

limited liability and mechanism design in procurement in the presence of cost uncertainty limited liability introduces the possibility of default in procurement with its associated bankruptcy costs when nancial soundness is not perfectly observable we show that incentive compatibility implies that nancially less sound contractors are selected with higher probability in any feasible mechanism informational rents are associated with unsound nancial situations by selecting the nancially weakest contractor stronger price competition auctions may not only increase the probability of default but also expected rents thus weak conditions are su cient for auctions to be suboptimal in particular we show that pooling rms with higher assets may reduce the cost of procurement even when default is costless for the sponsor

optimal allocation with ex post verification and limited penalties several agents with privately known social values compete for a prize the prize is allocated based on the claims of the agents and the winner is subject to a limited penalty if he makes a false claim if the number of agents is large the optimal mechanism places all agents above a threshold onto a shortlist along with a fraction of agents below the threshold and then allocates the prize to a random agent on the shortlist when the number of agents is small the optimal mechanism allocates the prize to the agent who makes the highest claim but restricts the range of claims above and below

money supply announcements and the ex ante volatility of asset prices previous empirical studies have documented more volatile money grow th and money surprises more volatile asset price changes and increased responsiveness of asset prices to money surprises since the october 1 979 change in fed policy this paper studies the associations between money announcements and the ex ante volatility of asset prices in th e recent past results indicate that revisions of ex ante asset price volatility as measured from prices of stock index government debt gold and foreign currency options are significantly correlated with the surprise component of the weekly m1 release there is also evidence that money releases reduce volatility by resolving uncertainty copyright 1988 by ohio state university press

time varying volatilities and calculation of the weighted implied standard deviation rogalski tinic have reported a monthly pattern in ex post stock return variances that differs between small and large market capitalization firms maloney rogalski find that option prices reflect these monthly patterns ex ante this study extends maloney rogalski s work by devising an expiration specific weighted implied standard deviation wisd it is found that i the monthly patterns in one month wisds are basically similar to the monthly patterns in ex post variances detected by rogalski tinic for both large and small size firms and ii use of expiration specific wisds as opposed to standard composite wisds results in improved performance of option pricing models

a simple linear weighting scheme for black scholes implied volatilities a note abstract this study presents a piecewise linear weighting function for implied volatilities calculated from black scholes call and put prices a sensitivity analysis is conducted to compare black scholes prices calculated using the weighted implied volatilities to american model prices the analysis indicates that a relatively simple european model can provide close approximations to american prices

a model of auction contracts with liquidated damages abstract this paper develops an auction model in which the winning bidder has an opportunity to cancel the transaction and pay damages to the seller in the event of a default on the auction contract the winning bidder pays liquidated damages or loses a posted deposit when renegotiation is possible increasing the deposit has no effect on the seller s payoff unless the seller has some bargaining power and exogenously receives some information about the winning bidder under these conditions the seller s payoff is decreasing in the level of the deposit journal of economic literature classification number d44

stock price volatility mean reverting diffusion and noise abstract using weekly call option prices on twenty five stocks over a ten year period 1975 1985 and calls on the s p 500 stock index futures we find that ex ante market volatility follows a mixed mean reverting diffusion with noise process changes in volatility are correlated across stocks and a marketwide volatility effect is found strong forces pull the volatility back to its long term value the findings suggest the development of new option pricing models

valuation of american options on foreign currency abstract pricing models for american call and put options on foreign currency are derived herein these models are used to investigate the efficiency of the market for foreign currency options the evidence presented here indicates that market prices for these options deviate substantially from their corresponding model prices in addition it is shown that a hedging strategy executed at transaction prices can be used to translate an observed deviation of market from model prices into positive excess profits however these profits are eliminated if the strategy is executed at bid and offer prices

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

strategic trading in a two sided foreign exchange auction abstract the market microstructure chosen for foreign exchange markets can influence trading volumes and equilibrium exchange rates with emerging markets and developing countries increasingly utilizing two sided auctions we show that the choice of the discrete t tonnement auction creates incentives for strategic behavior among market participants theoretical predictions on strategic under revelation of demand or supply positions are supported empirically using detailed data from a rare example of a t tonnement market the moscow interbank currency exchange our results suggest that market microstructures should be introduced alongside more traditional asset market fundamentals in studies of foreign exchange market activity especially in developing countries

the relation between price changes and trading volume a survey this paper reviews previous and current research on the relation between price changes and trading volume in financial markets and makes four contributions first two empiri cal relations are established volume is positively related to the magnitude of the price change and in equity markets to the price change per se second previous theoretical research on the price volume relation is summarized and critiqued and major insights are emphasized third a simple model ofthe price volume relation is proposed that is consis tent with several seemingly unrelated or contradictory observations and fourth several directions for future research are identified

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

does the law of one price hold in international financial markets evidence from tick data abstract this paper investigates the validity of the law of one price lop in international financial markets by examining the frequency size and duration of inter market price differentials for borrowing and lending services one way arbitrage using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency we find that the lop holds on average but numerous economically significant violations of the lop arise the duration of these violations is high enough to make it worthwhile searching for one way arbitrage opportunities in order to minimize borrowing costs and or maximize earnings on given funds we also document that such opportunities decline with the pace of the market and increase with market volatility

stealth trading which traders trades move stock prices usingaudit trail data for a sample of nyse firms we show that medium size trades are associated with a disproportionately large cumulative stock price change relative to their proportion of all trades and volume this result is consistent with the predictions of barclay and warner s 1993 stealth tradinghypothesis we find that the source of this disproportionately large cumulative price impact of medium size trades is trades initiated by institutions this result is robust to various sensitivity checks our findings appear to confirm street lore that institutions are informed traders 2001 elsevier science s a all rights reserved

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

informed traders and limit order markets abstract we consider a dynamic limit order market in which traders optimally choose whether to acquire information about the asset and the type of order to submit we numerically solve for the equilibrium and demonstrate that the market is a volatility multiplier prices are more volatile than the fundamental value of the asset this effect increases when the fundamental value has high volatility and with asymmetric information across traders changes in the microstructure noise are negatively correlated with changes in the estimated fundamental value implying that asset betas estimated from high frequency data will be incorrect

tests of an american option pricing model on the foreign currency options market this paper tests the ability of the american option pricing model proposed by parkinson 18 or mason 14 to explain the pricing of the foreign currency options traded on the philadelphia stock exchange from february 28 1983 to march 26 1985 we find that the model underprices out of the money options relative to at the money and in the money options this relative underpricing is driven by an underpricing of out of the money call options of short maturity in addition the degree of relative mispricing for most categories of options is shown to be a decreasing function of the time to maturity of the options longer maturity options appear to trade at similar levels of implied volatility whether they are in at or out of the money most of these biases appear consistent with the fact that the underlying spot currency rate follows a mixed jump diffusion process as described in 17

location matters an examination of trading profits the electronic trading system xetra of the german security exchange provides a unique data source on the equity trades of 756 professional traders located in 23 different cities and eight european countries we explore informational asymmetries across the trader population traders located outside germany in non german speaking cities show lower proprietary trading profit their underperformance is not only statistically significant it is also of economically significant magnitude and occurs for the 11 largest german blue chip stocks we also examine whether a trader location in frankfurt as the financial center or local proximity of the trader to the corporate headquarters of the traded stock or affiliation with a large financial institution results in superior trading performance the data provide no evidence for a financial center advantage or of increasing institutional scale economies in proprietary trading however we find evidence for an information advantage due to corporate headquarters proximity for high frequency intraday trading

the efficiency of the finnish market for right issues abstract this paper analyzes the efficiency of the finnish market for right issues the rights traded on the helsinki stock exchange hse are similar instruments to warrants with some special features attached to them the paper first derives appropriate arbitrage conditions for these rights which must be satisfied in informationally efficient markets and then examines these conditions using both ex post and ex ante test procedures the ex post tests which jointly examine market efficiency and synchroneity of the rights and stock market show a staggering amount of violations against the arbitrage bounds however the ex ante tests reveal that high transaction costs prevent normal investors from benefitting from these violations stockbrokers themselves however seem to be able to earn arbitrage profits in the rights market

the persistence of volatility and stock market fluctuations this paper examines the potential influence of changing volatility in stock market prices on the level of stock market prices it demonstrates that volatility is only weakly serially correlated implying that shocks to volatility do not persist these shocks can therefore have only a small impact on stockmarket prices since changes in volatility affect expected required rates of return for relatively short intervals these findings lead us to be skeptical of recent claims that the stock market s poor performance during the 1970 s can be explained by volatility induced increases in risk premia this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item

optimal procurement mechanisms we analyze optimal mechanisms in environments where sellers are privately informed about quality a methodology is provided for deriving conditions that are necessary and sufficient to determine when two simple trading environments maximize either social or private surplus the commonly used auction mechanism is frequently inefficient in procurement environments often the optimal mechanism is simply to order potential suppliers and to tender take it or leave it offers to each sequentially we completely characterize the environments in which either mechanism is optimal in doing so we develop a general methodology that determines when and if a given trading institution is optimal

on the valuation of american call options on stocks with known dividends both the roll and the geske equations for the valuation of the american call option on a stock with known dividends are incorrectly specified this note presents the corrected valuation formula explains the misspecifications and provides a numerical example

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

speed algorithmic trading and market quality around macroeconomic news announcements this paper documents that speed is crucially important for high frequency trading strategies based on u s macroeconomic news releases using order level data on the highly liquid s p 500 etf traded on nasdaq from january 6 2009 to december 12 2011 we find that a delay of 300 ms or more significantly reduces returns of news based trading strategies this reduction is greater for high impact news and on days with high volatility in addition we assess the effect of algorithmic trading on market quality around macroeconomic news in the minute following a macroeconomic news arrival algorithmic activity increases trading volume and depth at the best quotes but also increases volatility and leads to a drop in overall depth quoted half spreads decrease increase when we measure algorithmic trading over the full top of the order book

unbiased estimation of the black scholes formula abstract the black scholes model gives the price of an option as a function of the true variance rate of the underlying stock and other parameters because the true variance rate is unobservable an estimate of the variance rate is used in empirical tests but because the black scholes formula is non linear in the variance option price estimates using an estimated variance are biased even if the variance estimate itself is unbiased this paper develops an unbiased estimator of the black scholes formula from a taylor series expansion of the formula and the properties of the pdf of the estimated variance

anticipation of quarterly earnings announcements a test of option market efficiency abstract this study tests chicago board options exchange efficiency by examining option price behavior in the weeks surrounding a firm s quarterly earnings announcement the evidence presented here suggests that a first order autoregressive seasonal process describes quarterly earnings behavior and demonstrates that the information content of an earnings announcement is fully incorporated in option prices by the end of the announcement week

trading activity dealer concentration and foreign exchange market quality abstract we study the relation between foreign exchange market quality and both trading activity and dealer concentration by considering two currency pairs with significant differences along both dimensions the euro us dollar and canadian dollar us dollar a variance ratio test reveals over reaction in currency prices but that this is smallest when trading activity is high and dealer concentration at its peak a garch model shows that over reaction declines as trading activity and dealer concentration increase with the results being stronger for the euro our results confirm that trading activity is an important determinant of market quality but also point to a significant role for dealer concentration

local information in foreign exchange markets abstract this study shows that order flow in a foreign exchange market appears to have permanent price impact only if it comes from certain regions these regions are as predicted by the local information hypothesis centers of political and financial decision making it is revealing that orders from other regions only show a very short lived but no permanent price impact local information is so important that it carries over from the usually considered market orders to aggressively priced limit orders too the finding is robust to common news shocks to the consideration of feedback trading and to further controls

the stochastic behaviour of market variance implied in the prices of index options the purpose of this paper is to examine the time series properties of volatilities and to consider various financial and real variables that may be correlated with innovations in expected volatility the measure used in this study is the black scholes volatility implied in weekly call option prices written on the spot price of the ftse index a u k market equity index first the authors determine if capital structure can explain the relation between changes in the volatility of equity and structure can explain the relation between changes in the volatility of equity and changes in the level of the index second they analyze whether innovations in the volatilities of prices of real variables could also explain changes in equity volatility including the volume of transactions in equities oil prices exchange rates nominal and real interest rates and inflation copyright 1991 by royal economic society

valuation of american futures options theory and empirical tests this paper reviews the theory of futures option pricing and tests the valuation principles on transaction prices from the s p 500 equity futures option market the american futures option valuation equations are shown to generate mispricing errors which are systematically related to the degree the option is in the money and to the option s time to expiration the models are also shown to generate abnormal risk adjusted rates of return after transaction costs the joint hypothesis that the american futures option pricing models are correctly specified and that the s p 500 futures option market is efficient is refuted at least for the sample period january 28 1983 through december 30 1983 futures option contracts now trade on every major futures exchange and on a wide variety of underlying futures contracts the chicago mercantile exchange the chicago board of trade the new york futures exchange and the commodity exchange now collectively have more than twenty options written on futures contracts where the underlying spot commodities are financial assets such as stock portfolios bonds notes and eurodollars foreign currencies such as west german marks swiss francs and british pounds precious metals such as gold and silver livestock commodities such as cattle and hogs and agricultural commodities such as corn and soybeans moreover new contract applications are before the commodity futures trading commission and should be actively trading in the near future with the markets for these new contingent claims becoming increasingly active it is appropriate that the fundamentals of futures option valuation be reviewed and tested black 5 provides a framework for the analysis of commodity futures options although his work is explicitly directed at pricing european options on forward contracts it applies to european futures contracts as well if the riskless rate of interest is constant during the futures option life 1 the options currently

the submission of limit orders or market orders the role of timing and information in the reuters d2000 2 system abstract recent work in the market microstructure literature suggests that the speed with which orders arrive in the market impacts traders order submission decisions in this study we use an asymmetric autoregressive conditional duration acd model to empirically investigate the influence on the submission of limit and market orders of changes in the time between the past submissions of different types of orders changes in the slope of the limit order book and changes in price uncertainty we find that the expected time between the arrivals of successive orders in the foreign exchange market depends on the previous type of order submitted and the slope on both sides of the order book price uncertainty volatility plays a secondary role after accounting for the impact of changes in the slope of the order book lastly we find that there are fundamental changes in the level of information contained in the submission of orders at the opening and closing of markets

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

how to design infrastructure contracts in a warming world a critical appraisal of public private partnerships we analyze how long term uncertainty for example regarding future climate conditions affects the design of concession contracts and organizational forms in a principal agent context with dynamic moral hazard limited liability and irreversibility constraints the prospect of future uncertain productivity shocks on the returns on the firm s effort creates an option value of delaying efforts a course that exacerbates agency costs contracts and organizational forms are drafted to control this cost of delegated flexibility the possibility for the agent to delay investment in response to uncertainty and irreversibility also elicits preference for unbundling different stages of the project through short term contracts our analysis is relevant to infrastructure sectors that are sensitive to changing weather conditions and sheds a pessimistic light on the relevance of public private partnerships in this context

competition signaling and non walking through the book effects on order choice abstract we investigate the effects of competition and signaling in a pure order driven market and examine the trading patterns of agents when walking through the book is not allowed our results suggest that the variables capturing the cost of a large market order are not informative for an impatient trader under this market mechanism we also document that the competition effect is not present only at the top of the book but persistent beyond the best quotes moreover it dominates the signaling effect for both a limit order and a market order trader finally we show that institutional investors order submission strategies are characterized by only a few pieces of the limit order book information this is consistent with informed traders placing orders based on their own private valuations rather than the state of the book

high bids and broke winners abstract this paper analyzes auctions where budget constrained bidders have options to declare bankruptcy it predicts a bidding equilibrium that changes discontinuously in a borrowing rate available to bidders when the borrowing rate is above a threshold high budget bidders win and the likelihood of bankruptcy is low when the borrowing rate is below the threshold the winner is the most budget constrained bidder and is most likely to declare bankruptcy this result explains the high bids and broke winners anomaly in the c block fcc spectrum auction based on its equilibrium analysis the paper proves that a seller can profit from offering to finance the highest bidder at a below market interest rate even with default risk journal of economic literature classification numbers d44 d45 d82 g33 l96

aggressive oil extraction and precautionary saving coping with volatility the effects of stochastic oil demand on optimal oil extraction paths and tax spending and government debt policies are analyzed when the oil demand schedule is linear and preferences quadratic without prudence optimal oil extraction is governed by the hotelling rule and optimal budgetary policies by the tax and consumption smoothing principle volatile oil demand brings forward oil extraction and induces a bigger government surplus with prudence the government depletes oil reserves even more aggressively and engages in additional precautionary saving financed by postponing spending and bringing taxes forward especially if it has substantial monopoly power on the oil market gives high priority to the public spending target is very prudent and future oil demand has high variance uncertain economic prospects induce even higher precautionary saving and if non oil revenue shocks and oil revenue shocks are positively correlated even more aggressive oil extraction in contrast prudent governments deliberately underestimate oil reserves which induce less aggressive oil depletion and less government saving but less so if uncertainty about reserves and oil demand are positively correlated

a bayesian approach to modeling stock return volatility for option valuation new measures of stock return volatility are developed to increase the precision of stock option price estimates with bayesian statistical methods volatility estimates for a given stock are developed using prior information on the cross sectional patterns in return volatil ities for groups of stocks sorted on size financial leverage and trading volume call option values computed with the bayesian procedure generally improve prediction accuracy for market prices of call options relative to those computed using implied volatility standard historical volatility or even the actual ex post volatility that occurred during each option s life although the bayesian methods produce biased call price estimators they do reduce the systematic tendency of standard pricing approaches to overprice underprice options on high low volatility stocks little bias improvement is observed with respect to the time to maturity and moneyness of the call options

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

the systematic risk of discretely rebalanced option hedges this paper demonstrates that black scholes option pricing model hedge positions that are risk free when rebalanced continuously will frequently exhibit substantial systematic risk when rebalanced at finite intervals this systematic risk may have biased important empir ical tests of the option pricing model moreover this systematic risk means that the blackscholes option pricing model is inherently inconsistent with the discrete time version of the capital asset pricing model capm