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

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

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

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

tracking the market dynamic pricing and learning in a changing environment dynamic pricing of commodities without knowing the exact relation between price and demand is a much studied problem most existing studies assume that the parameters describing the market are constant during the selling period this severely reduces their practical applicability since in reality market characteristics may change all the time without the firm always being aware of it in the present paper we study dynamic pricing and learning in a changing market environment we introduce a methodology that enables the price manager to hedge against changes in the market and provide explicit upper bounds on the regret a measure of the performance of the firm s pricing decisions in addition this methodology guides the selection of the optimal way to estimate the market process we provide numerical examples from practically relevant situations to illustrate the methodology

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

explaining patterns of candidate competition in congressional elections the low probability of defeating incumbent members of congress deters potentially strong rivals from challenging them yet almost all incumbents are challenged usually by opponents who lack previous experience in office and run underfinanced ineffectual campaigns but if strong challengers are deterred from challenging incumbents why are not weak challengers who have even less chance of unseating an incumbent the model developed in this paper indicates that there is a simple reason why weak candidates choose to run against incumbents they do so in order to maximize their probability of getting elected to congress together with the findings of previous researchers the results of our analyses of congressional primary data from 1980 through 1984 provide strong support for the major hypotheses derived from our model

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

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

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

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

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

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

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

leverage effect volatility feedback and self exciting market disruptions equity index volatility variation and its interaction with the index return can come from three distinct channels first index volatility increases with the market s aggregate financial leverage second positive shocks to systematic risk increase the cost of capital and reduce the valuation of future cash flows generating a negative correlation between the index return and its volatility regardless of financial leverage finally large negative market disruptions show self exciting behaviors this article proposes a model that incorporates all three channels and examines their relative contribution to index option pricing and stock option pricing for different types of companies

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

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

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

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

modeling and estimation in changing market environments in many marketing contexts managers and researchers are concerned with modeling the response of performance variables e g sales or market share to one or more decision variables e g advertising or price or other predictor variables modeling efforts in these contexts may consider either the response of an individual entity such as a single consumer or firm or the aggregate response of a collection of entities usually they involve the specification of mathematical models where the unknown parameters are assumed a priori to be constant these unknown parameters are then estimated by fitting the models to available data using some form of regression analysis the rationale for expending effort in this area is the expectation that through activities of this type the decision maker gains understanding of the market process and therefore is able to make better decisions the response of a firm s market performance to decision predictor variables may be moderated by numerous external factors by competitive factors and by the levels of the firm s decision variables for example the sensitivity of sales to price may vary depending on time of year overall economic conditions and or levels of advertising or promotion certain characteristics of marketing research is often concerned with the modeling of market response over time however the nature of the relationships being modeled may change due to shifts in consumer tastes changing marketing strategies competition and other reasons currently used constant parameter models are not capable of adequately reflecting such changing market environments therefore alternate modeling approaches should be considered recent work in statistics and econometrics suggests the appropriateness of variable parameter models for such problems this methodology permits model coefficients to change over time in this paper various potentially useful variable parameter models are discussed reported marketing applications are examined and issues pertaining to the application of this relatively new methodology to marketing problems are investigated professor winer gratefully acknowledges support from the faculty research fund of the graduate school of business columbia university professor wildt was on the faculty of the university of georgia when the paper was written

consumer learning in a turbulent market environment modeling consumer choice dynamics after a product harm crisis abstract the authors empirically study consumer choice behavior in the wake of a product harm crisis which creates consumer uncertainty about product quality they develop a model that explicitly incorporates the impact of such uncertainty on consumer behavior assuming that consumers are uncertain about the mean product quality level and learn about product quality through the signals contained in use experience and the product harm crisis and also that consumers are uncertain about the precision of the signals in conveying product quality and update their perception of this precision over time they estimate this model using a scanner panel data set that includes consumer purchase history before during and after a product harm crisis that affected kraft foods australia s peanut butter division in june 1996 the proposed model fits the data better than the standard consumer learning model which assumes consumers are uncertain about product quality level but the precision of information in conveying p

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

using multimember district elections to estimate the sources of the incumbency advantage in this article we use a novel research design that exploits unique features of multimember districts to estimate and decompose the incumbency advantage in state legislative elections like some existing related studies we also use repeated observations on the same candidates to account for unobserved factors that remain constant across observations multimember districts have the additional feature of copartisans competing for multiple seats within the same district this allows us to identify both the direct office holder benefits and the incumbent quality advantage over nonincumbent candidates from the same party we find that the overall incumbency advantage is of similar magnitude as that found in previous studies we attribute approximately half of this advantage to incumbents quality advantage over open seat candidates and the remainder to direct office holder benefits however we also find some evidence that direct office holder benefits are larger in competitive districts than in safe districts and in states with relatively large legislative budgets per capita

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

a two stage sales forecasting procedure using discounted least squares the authors develop a two stage forecasting methodology for estimating the sales responses to marketing and environmental variables when it is likely that their impacts will change unpredictably over time the methodology is based on an integrated least squares procedure that uses regression analysis in stage 1 to estimate the coefficients of the controllable and environmental variables in combination with a stage 2 discounted least squares smoothing procedure that updates key parameters in response to changing market conditions the effectiveness of the methodology is demonstrated by applying it to weekly sales data from a major retail chain

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

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

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

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

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

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

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

old voters new voters and the personal vote using redistricting to estimate the incumbency advantage we provide new estimates of the size of the personal vote in u s house elections from 1872 to 1990 we take advantage of the natural experiment that attends decennial redistricting every ten years most incumbents are given new districts that contain a combination of old and new territory by contrasting an incombent s vote in the new part of the district with his or her vote in the old part of the district we can estimate the magnitude of the personal vote the vote that the incumbent receives because he or she represented the voters in the past our estimates confirm prior work that shows that a large fraction of the incumbency advantage owes to the personal vote as opposed to challenger quality unlike past research we are able to estimate the relationship between district partisanship and the personal vote we find a significant interaction which shows that incumbents develop larger personal votes in areas where they are electorally most vulnerable here is no doubt that incumbents today have a substantial advantage over nonincumbents in u s house elections the overall size of this advantage has been fairly well established as has the fact that incumbents electoral strength has increased dramatically over the postwar period measured in terms of vote share the overall incumbency advantage grew from a modest 1 3 percentage point edge in the 1940s and early 1950s to a 7 10 percentage point edge in the 1980s and early 1990s 1 there is much less agreement about the sources of the incumbency advantage and the causes of its growth congressional scholars have identified a variety of factors that may be responsible which can be grouped into three broad categories the first and the focus of this paper is electoral advantage that stems from a legislator s homestyle members of the house are reputedly very responsive to their constituents in turn their constituents reward them with their votes mayhew 1974b fenno 1974 and others detail the sorts of activities that legislators do to build a widely known and respected name including casework frequent visits to the district position taking on issues and securing federal benefits a second source of the incumbency advantage is candidate quality incumbents may win because they are the best candidates running and they do noticeably worse when they face state legislators and other experienced challengers finally incumbency may simply act as a voting cue a label which voters rely on because party has become less relevant assessing the importance of these different factors has significant implications for our normative evaluations of the modern congress and our understanding

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

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

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

why did the incumbency advantage in u s house elections grow theory a simple rational entry argument suggests that the value of incumbency consists not just of a direct effect reflecting the value of resources such as staff attached to legislative office but also of an indirect effect reflecting the fact that stronger challengers are less likely to contest incumbent held seats the indirect effect is the product of a scare off effect the ability of incumbents to scare off high quality challengers and a quality effect reflecting how much electoral advantage a party accrues when it has an experienced rather than an inexperienced candidate hypothesis the growth of the overall incumbency advantage was driven principally by increases in the quality effect methods we use a simple two equation model estimated by ordinary least squares regression to analyze u s house election data from 1948 to 1990 results most of the increase in the incumbency advantage at least down to 1980 came through increases in the quality effect i e the advantage to the incumbent party of having a low quality challenger this suggests that the task for those wishing to explain the growth in the vote denominated incumbency advantage is to explain why the quality effect grew it also suggests that resource based explanations of the growth in the incumbency advantage cannot provide a full explanation

challenger entry and voter learning we develop a model of strategic interaction between voters and potential electoral challengers to sitting incumbents in which the very fact of a costly challenge conveys relevant information to voters given incumbent failure in office challenger entry is more likely but the threat of entry by inferior challengers creates an incentive for citizens to become more politically informed at the same time challenges to incumbents who perform well can neutralize a voter s positive assessment of incumbent qualifications how a voter becomes politically informed can in turn deter challengers of different levels of competence from running depending on the electoral environment the model permits us to sharpen our understanding of retrospective voting the incumbency advantage and the relationship between electoral competition and voter welfare while pointing to new interpretations of and future avenues for empirical research on elections

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

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

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

dynamic models incorporating individual heterogeneity utility evolution in conjoint analysis it has been shown in the behavioral decision making marketing research and psychometric literature that the structure underlying preferences can change during the administration of repeated measurements e g conjoint analysis and data collection because of effects from learning fatigue boredom and so on in this research note we propose a new class of hierarchical dynamic bayesian models for capturing such dynamic effects in conjoint applications which extend the standard hierarchical bayesian random effects and existing dynamic bayesian models by allowing for individual level heterogeneity around an aggregate dynamic trend using simulated conjoint data we explore the performance of these new dynamic models incorporating individual level heterogeneity across a number of possible types of dynamic effects and demonstrate the derived benefits versus static models in addition we introduce the idea of an unbiased dynamic estimate and demonstrate that using a counterbalanced design is important from an estimation perspective when parameter dynamics are present

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

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

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

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

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

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

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

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

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

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

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

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

chapter 9 econometric and time series market response models publisher summary marketing has seen a rapid expansion in the widespread use of quantitative methods correlation and regression analysis were among the first techniques used as marketing research emerged as a discipline after world war ii in the early 1970s regression analysis became econometrics simultaneous equation systems could be estimated almost as easily as single regression equations while econometrics as a whole continues to flourish as new and more sophisticated estimation techniques and associated computer software have become available simultaneous equation systems have not become widely prevalent the dynamic structure of marketing variables themselves is addressed in the chapter followed by discussions of leads and lags among marketing variables and the assessment of the direction of causality dynamic properties of sales response functions have been discussed in more detail marketing generalizations that have been uncovered as well as empirical evidence on the shape of the sales response function is reported

party cues in elections under multilevel governance theory and evidence from us states this is the authors accepted refereed and final manuscript to the article the final publication is available at www elsevier com

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

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

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

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

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

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

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

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

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

estimating incumbency advantage without bias in this paper we prove theoretically and demonstrate empirically that all existing measures of incumbency advantage in the congressional elections literature are biased or inconsistent we then provide an unbiased estimator based on a very simple linear regression model we apply this new method to congressional elections since 1900 providing the first evidence of a positive incumbency advantage in the first half of the century incumbency advantage is the most frequently studied factor in the last 15 years of congressional elections research discovery of the increase in incum bency advantage has sparked controversy over its origins historical pattern cur rent magnitude and electoral democratic and policy consequences even the most basic descriptive information about incumbency advantage is flawed be cause every previous measure based on aggregate data in this literature is plagued by selection bias inconsistencies and inefficiencies we prove this result and also propose a new unbiased and statistically efficient measure that is very easy to calculate congressional elections from 1900 to the present fit our theoretical model our empirical reanalyses do not challenge the existing scholarly consen sus that incumbency advantage is much larger than it once was however we do challenge the prevailing belief that incumbency advantage was nonexistent and the evidence that it was negative in house elections during the first half of this century alford and brady 1988 we show instead that the average advantage of incumbency in these elections was about two percentage points in section 1 of this paper we define incumbency advantage and section 2 gives an intuitive sense of the problems identifying it even in ideal electoral sys tems section 3 formally proves that sophomore surge and retirement slump are biased estimates of incumbency advantage and section 4 briefly reveals the flaws

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

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

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

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