stochastic modeling of financial electricity contracts abstract we discuss the modeling of electricity contracts traded in many deregulated power markets these forward futures type contracts deliver either physically or financially electricity over a specified time period and is frequently referred to as swaps since they in effect represent an exchange of fixed for floating electricity price we propose to use the heath jarrow morton approach to model swap prices since the notion of a spot price is not easily defined in these markets for general stochastic dynamical models we connect the spot price the instantaneous delivery forward price and the swap price and analyze two different ways to apply the heath jarrow morton approach to swap pricing either one specifies a dynamics for the non existing instantaneous delivery forwards and derives the implied swap dynamics or one models directly on the swaps the former is shown to lead to quite complicated stochastic models for the swap price even when the forward dynamics is simple the latter has some theoretical problems due to a no arbitrage condition that has to be satisfied for swaps with overlapping delivery periods to overcome this problem a practical modeling approach is analyzed the market is supposed only to consist of non overlapping swaps and these are modelled directly a thorough empirical study is performed using data collected from nord pool our investigations demonstrate that it is possible to state reasonable models for the swap price dynamics which is analytically tractable for risk management and option pricing purposes however this is an area of further research

transparency preference and economic behavior it is shown that decision makers guided by popperian epistemology will have a preference for transparency even in situations where standard economic theory provides no rationale for such a preference this provides a popperian resolution of the ellsberg paradox and a rationale for suspicion in experiments as well as in economic life

why does junior put all his eggs in one basket a potential rational explanation for holding concentrated portfolios abstract empirical studies of household portfolios show that young households with little financial wealth hold underdiversified portfolios that are concentrated in a small number of assets a fact often attributed to behavioral biases we present a potential rational alternative we show that investors with little financial wealth who receive labor income rationally limit the number of assets they invest in when faced with financial constraints such as margin requirements and restrictions on borrowing we provide theoretical and numerical support for our results and identify the ratio of financial wealth to labor income as a useful control variable for household portfolio studies

the costs and beliefs implied by direct stock ownership this paper develops and estimates an economic model of the costs and beliefs required to rationalize household direct stock ownership in the model investors believe they can learn information about individual stock returns through costly research the model identifies the distributions of both research costs and beliefs about the predictability of individual stock returns identification depends only on households wealth and portfolio choices the model also provides a novel explanation for many empirical features of household portfolios parameter estimates suggest that most households have modest beliefs about the benefits of individual stock research although a minority must expect extraordinary returns data are available at https doi org 10 1287 mnsc 2017 2791 this paper was accepted by neng wang finance

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

correlations in price changes and volatility across international stock markets the short run interdependence of prices and price volatility across three major international stock markets is studied daily opening and closing prices of major stock indexes for the tokyo london and new york stock markets are examined the analysis utilizes the autoregressive conditionally heteroskedastic arch family of statistical models to explore these pricing relationships evidence of price volatility spillovers from new york to tokyo london to tokyo and new york to london is observed but no price volatility spillover effects in other directions are found for the pre october 1987 period article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

does investor recognition predict returns abstract merton 1987 a simple model of capital market equilibrium with incomplete information journal of finance 42 483 510 shows that stocks about which not all investors are informed should yield a return premium this premium depends on the shadow cost of incomplete information which in turn depends on the shareholder base relative market size and idiosyncratic risk utilizing a comprehensive database of swedish shareholdings we demonstrate that stock returns are positively related to the shadow cost we also find that the shareholder base is negatively related to returns when controlling for size and idiosyncratic risk zero cost portfolios based on the shadow cost shareholder base yield substantial trading profits that are never positively correlated with the market and are only modestly explained by the four factor model

testing and valuing dynamic correlations for asset allocation we evaluate alternative models of variances and correlations with an economic loss function we construct portfolios to minimize predicted variance subject to a required return it is shown that the realized volatility is smallest for the correctly specified covariance matrix for any vector of expected returns a test of relative performance of two covariance matrices is based on work of diebold and mariano the method is applied to stocks and bonds and then to highly correlated assets on average dynamically correct correlations are worth around 60 basis points in annualized terms but on some days they may be worth hundreds

risk aversion in the large and in the small estimates of agents risk aversion differ between market studies and experimental studies we demonstrate that these estimates can be reconciled through consistent treatment of agents propensity for narrow framing

tree structured multiple regimes in interest rates this article develops a generalized tree structured gts model of the short term interest rate that accommodates regime dependent mean reversion and regime dependent volatility clustering and level effects in the conditional variance the model is constructed using the idea of multivariate tree structured thresholds and nests the popular generalized autoregressive conditional heteroscedasticity and square root processes as simple special cases it allows us to estimate the optimal number of regimes endogenously from the data and to exploit possible additional information in the term structure and in other macroeconomic variables we provide empirical evidence of the strong potential of the gts model in forecasting conditional first and second moments also in comparison with alternative models of the short rate

a utility based comparison of some models of exchange rate volatility abstract when estimates of variances are used to make asset allocation decisions underestimates of population variances lead to lower expected utility than equivalent overestimates a utility based criterion is asymmetric unlike standard criteria such as mean squared error to illustrate how to estimate a utility based criterion we use five bilateral weekly dollar exchange rates 1973 1989 and the corresponding pair of eurodeposit rates of homoskedastic garch autoregressive and non parametric models for the conditional variance of each exchange rate garch models tend to produce the highest utility on average a mean squared error criterion also favors garch but not as sharply

realized volatility and price spikes in electricity markets the importance of observation frequency abstract this paper uses high frequency spot price data from eight wholesale electricity markets in australia canada and the united states to estimate realized volatility and the frequency of price spikes i find similar levels of realized volatility in australia and north america with estimates ranging from 1500 to 2700 much greater than estimates reported previously in the literature in hourly data the frequency of price spikes ranges from approximately 35 to 40 in seven of eight markets i present evidence that increasing the lag length in the calculation of bipower variation improves jump detection in electricity prices

asymmetric volatility transmission in international stock markets abstract the transmission mechanism of price and volatility spillovers across the new york tokyo and london stock markets is investigated the asymmetric impact of good news market advances and bad news market declines on volatility transmission is described by an extended multivariate exponential generalized autoregressive conditionally heteroskedastic egarch model using daily open to close returns we find strong evidence that volatility spillovers in a given market are much more pronounced when the news arriving from the last market to trade is bad a before and after october 1987 crash analysis reveals that the linkages and interactions among the three markets have increased substantially in the post crash era suggesting that national markets have grown more interdependent

flexible multivariate garch modeling with an application to international stock markets this paper offers a new approach to estimating time varying covariance matrices in the framework of the diagonal vech version of the multivariate garch 1 1 model our method is numerically feasible for large scale problems produces positive semidefinite conditional covariance matrices and does not impose unrealistic a priori restrictions we provide an empirical application in the context of international stock markets comparing the new estimator with a number of existing ones

household portfolio diversification a case for rank dependent preferences the proliferation of novel preference theories in financial economics is hampered by a lack of non experimental evidence and by the theories additional complexity which has not been shown to be critical in applications in this article i present arguments in support of preferences with rank dependency using the survey of consumer finances data i document two widespread patterns inconsistent with expected utility i many households simultaneously invest in well deversified funds and in poorly diversified portfolios of stocks and ii some households with substantial savings do not invest anything in equities i show that portfolio choice models with rank dependent preferences plausibly parameterized and under fully rational assumptions are quantitatively consistent with the observed diversification these results call for further efforts to integrate the models of rank dependent preferences in portfolio theory and asset pricing the decision theoretic literature has long acknowledged the shortcomings of the expected utility theory of von neumann and morgenstern 1944 several generalizations of the theory are inspired by the experimental evidence and aimed at improving its descriptive accuracy however there are few applications of new models of preferences in finance and expected utility continues to dominate the field 1 two principal hurdles slow the proliferation of novel preferences in financial economics first the lack of empirical non experimental or field data confirming that the behavior motivating non expected utilities is widespread outside the laboratory settings second the additional and often significant complexity of the alternative preferences which has not been shown to be critical in applications where the models based on expected utility fall short of reasonable predictions this article presents empirical and theoretical this paper was previously circulated under the title household portfolio diversification the paper has benefited from the comments of shlomo benartzi luca benzoni markus brunnermeier john dickhaut maria perozek raj singh hersh shefrin and workshop participants at minnesota finance bag lunch 2003 wharton conference household financial decision making and portfolio choice and 2003 summer meetings of econometric society i would like to thank cam harvey the editor and an anonymous referee for many helpful comments and suggestions a special thanks to jack kareken for comments and editorial help on an earlier draft i am grateful to donna zerwitz for editorial assistance the views expressed herein are those of the author and not necessarily of the federal reserve bank of minneapolis or the federal reserve system all errors and omissions are the sole responsibility of the author address correspondence to valery polkovnichenko finance 3 122 csom 319 19 th

economic news and equity market linkages between the u s and u k abstract the source of equity market linkages between the u s and u k is investigated by focusing on intraday price movements of stock index futures contracts we document heightened u k return volatility at 11 30 a m and 1 30 p m gmt which corresponds to regular macroeconomic releases in the u k and u s respectively the response of u k equities in the half hour surrounding the u s announcements is significant and similar to price movements for u s equities to the same announcements these results support the hypothesis that the documented international equity market linkages are attributable to reactions of foreign traders to public information originating from the u s

why do so few hold stocks the authors investigate why 75 percent of u s households do not hold stocks despite the equity premium and predictions of expected utility models the question is relevant for privatization asset pricing and tax progressivity issues they show that risk aversion per se heterogeneity of beliefs habit persistence time nonseparability and quantity constraints on borrowing do not account for the phenomenon a wedge between borrowing and lending rates and minimum investment requirements are plausible but empirically weak factors more promising explanations are inertia and departures from expected utility maximization there is also qualified support for nondiversifiable income risk as a contributing factor copyright 1995 by royal economic society

meteor showers or heat waves heteroskedastic intra daily volatility in the foreign exchange market this paper seeks to explain the causes of volatility clustering in exchange rates careful examination of intra daily exchange rates provides a test of two hypotheses heat waves and meteor showers the heat wave hypothesis is that the volatility has only country specific autocorrelation alternatively the meteor shower is a phenomenon of intra daily volatility spillovers from one market to the next using the garch model to specify the heteroskedasticity across intra daily market segments we find that the empirical evidence is generally against the null hypothesis of the heat wave using a volatility type of vector autoregression we examine the impact of news in one market on the time path of per hour volatility in other markets

a general multivariate threshold garch model with dynamic conditional correlations we introduce a new multivariate garch model with multivariate thresholds in conditional correlations and develop a two step estimation procedure that is feasible in large dimensional applications optimal threshold functions are estimated endogenously from the data and the model conditional covariance matrix is ensured to be positive definite we study the empirical performance of our model in two applications using u s stock and bond market data in both applications our model has in terms of statistical and economic significance higher forecasting power than several other multivariate garch models for conditional correlations

all their eggs in one basket portfolio diversification of us households abstract this paper uses data from the survey of consumer finances to assess how well mean variance efficiency describes the portfolio diversification of us households it does not seem to work well the median stockholder owns a single publicly traded stock often in the company where he works looking at a sample of high income households who accounted for one third of all publicly traded stock the median holding is only ten stocks indirect stock ownership through mutual funds defined contribution pension plans ira s and trust funds is shown to have little power in explaining this poor diversification

estimating and predicting multivariate volatility thresholds in global stock markets we propose a general double tree structured ar garch model for the analysis of global equity index returns the model extends previous approaches by incorporating i several multivariate thresholds in conditional means and volatilities of index returns and ii a richer specification for the impact of lagged foreign us index returns in each threshold we evaluate the out of sample forecasting power of our model for eight major equity indices in comparison to some existing volatility models in the literature we find strong evidence for more than one multivariate threshold more than two regimes in conditional means and variances of global equity index returns such multivariate thresholds are affected by foreign us lagged index returns and yield a higher out of sample predictive power for our tree structured model setting

non gaussian diversification when size matters abstract classical portfolio theory informs investors that they should have a large number of assets in their portfolios in order to diversify risk we show that the non gaussian features of stock return distribution may not allow for this risk protection in times of crisis moreover we demonstrate empirically that if investors are risk averse and consider higher order moments they have numerous incentives not to diversify their portfolios fully this is caused by the evolution of both large losses and asymmetry of returns when the numbers of assets in a portfolio change