International Journal of Financial Markets and Derivatives (11 papers in press)
Stress Test Techniques Using Drawdown Metrics: A Brazilian Case Study
by Arthur Geronazzo, João Luiz Chela
Abstract: The main objective of investors is to obtain the highest return, by running the lowest risk. On the other hand, risk managers are responsible for monitoring the risks. This paper presents a series of risk metrics based on Maximum Drawdown historical. Maximum Drawdown provides the information of the largest drop in the asset value that an investor can have in a given time interval. The metrics use historical simulation with different time intervals, Holding Period and confidence levels. The backtest of these metrics is done to verify adherence, so it shows that the Maximum Drawdown at Risk using GEV metric is the metric that presents the highest approval rates. The main contribution of this paper is the presentation of different risk metrics based on Maximum Drawdown, analyse of the best metric for each situation and applications of the metrics to risk management and stress scenarios.
Keywords: Maximum Drawdown; Risk Metrics; Stress Test; Extreme Value Theory; Maximum Drawdown at Risk; Conditional Expected Drawdown.
A Theory of 'Auction as a Search' in Speculative Markets
by Sudhanshu Pani
Abstract: The tatonnement process in high frequency order driven markets is modeled as a search by buyers for sellers and vice-versa. We propose a total order book model, comprising limit orders and latent orders, in the absence of a market maker. A zero intelligence approach of agents is employed using a diffusion-drift-reaction model, to explain the trading through continuous auctions (price and volume). The search
(levy or brownian) for transaction price is the primary diffusion mechanism with other behavioural dynamics in the model inspired from foraging, chemotaxis and robotic search. Analytic and asymptotic analysis is provided for several scenarios and examples. Numerical simulation of the model extends our understanding of the relative performance between brownian, superdiffusive and ballistic search in the model.
Keywords: Market Microstructure; Levy Search; Limit order markets; Continuous
Auctions; High Resolution; Zero Intelligence;.
The valuation of options on index futures with stochastic dividend yields
by Enrique Zambrano, Rednaxela Sequera
Abstract: This paper develops a valuation model for European options on index futures considering the stochastic nature of dividend yields. In addition, this research examines two subjects: first, whether the assumption of stochastic dividend yields is relevant; and second, the models performance regarding the futures volatility curve. The model is calibrated using maximum likelihood estimation. The results suggest that the assumption of stochastic dividend yields has a significant influence in the valuation of options on index futures, even after considering commission costs. In addition, the model performs well in explaining the observed futures volatility curve. In this sense, the findings suggest that investment strategies based on mathematical models must consider the stochastic nature of dividend yields.
Keywords: index futures; futures options; option pricing; valuation model; stochastic dividend yields.
Country risk and increasing returns to credibility gains: analysis for an emerging economy
by Kiara De Deus Demura, Ricardo Ramalhete Moreira
Abstract: This article aimed to test how the monetary and fiscal policies` credibility impacts country risk by analyzing the case of a relevant emerging economy. We performed estimates through OLS and GMM which showed that fiscal credibility can negatively affect country risk, rather than monetary credibility. This evidence corroborated the role of fiscal consolidation in order to shape a low and consistent level of country risk. At last, based on MS-regressions, we identified non-linear credibility effects, which can be called increasing returns to fiscal credibility gains, thereby representing an innovation regarding previous studies.
Keywords: country risk; credibility gains; fiscal policy; monetary policy; increasing returns; Brazil.
Equilibrium in Options' Incomplete Markets
by Christos Kountzakis
Abstract: This paper is devoted to the use of the incomplete by options' markets in the existence of equilibrium in the case where a financial market remains incomplete, even after including any European Call and Put Options' Pay -off, written on the Pay- off of the initial markets' portfolios.
Keywords: Incomplete Markets; Finite -Dimensional Sub -lattices.
Liquidity in High Resolution in Limit Order Markets
by Sudhanshu Pani
Abstract: This paper investigates, in high resolution, the role of liquidity in a limit order market. Liquidity in these markets has two parts - a liquidity store and liquidity flow (time dimension). We model the liquidity residing in a limit order book and the liquidity flow from the latent order book, using a fully probabilistic model. Using a sample of stocks from NASDAQ 100, we find that liquidity residing in the order book, within five levels each on either side of the transaction price and the flow to this liquidity pool from the latent order book can explain the wealth traded through the trading system, when observed in business time. The explanatory power is satisfactory in high resolution and short periods of business time but weaker in aggregated longer time periods. We observe that the liquidity pool for large part of the trading day goes into a steady state equilibrium.
Keywords: High resolution; Liquidity; Vine copula regression; Bayesian hierarchial models; Limit order markets; Market Microstructure;.
Is Overreaction/Underreaction chosen by managers? Evidence from Greece.
by WILLIAM FORBES, L.E.N. SKERRATT, GEORGE GIANNOPOULOS
Abstract: This paper models overreaction/underreaction as being the outcome of company managers
Keywords: underreaction; selective earnings; earnings announcements; perceived mis-pricing.
Transition and measurement noise correlation in affine and Gaussian models: The case of oil prices
by Carla Souza, Fernando Aiube
Abstract: This paper proposes a new approach for the estimation of affine and Gaussian factor models with the Kalman filter method. It considers the correlation between the innovations of transition and measurement equations. We use crude oil prices in the analysis. When applying this correlation approach in two- and three-factor models, we obtain improvements of error measures between estimated and observed future prices with inexpensive estimation procedures.
Keywords: Commodity factor models; Kalman filter estimation; future prices; oil prices.
Coskewness, cokurtosis and their implications on asset pricing of cryptocurrencies
by Balint-Zsolt Nagy, Botond Benedek
Abstract: This study examines several asset pricing specifications applied for a sample of 72 cryptocurrencies. We extend the existing literature on asset pricing of cryptocurrencies by including higher co-moment factors, namely coskewness and cokurtosis. Our overall conclusion is that coskewness and cokurtosis are also priced in crypto-markets, but less pronouncedly than in equity/commodity/ derivatives markets. Size and momentum factors further increase explanatory power, but their regression coefficients are insignificant.
Keywords: cryptocurrency; Bitcoin; altcoins; coskewness; cokurtosis; asset pricing; excess returns; Fama-McBeth regressions.
Informed Trading or Liquidity Trading: A Theoretical Formulation
by Rebecca Abraham
Abstract: This paper provides theoretical formulations of informed trading contrasted with liquidity trading. Informed trading occurs when traders flock to purchase or sell securities, based upon private information. In contrast, liquidity traders purchase or sell securities for their own inventory, Informed traders purchase in large volume over very short periods of time, with a definite direction of price movement. Liquidity trading consists of unlimited market entry of traders, reducing profit per trader, along with a long time period of investment in which the direction of price movement is uncertain, diminishing gains. This paper presents optimal trade prices for informed traders prior to stock mergers, whereupon traders have been observed short selling the acquirer stock, using the proceeds to purchase target stock, or to purchase put options. A capital structure arbitrage strategy is used for liquidity traders, with the trader purchasing or selling bonds at trade prices influenced by the market makers prices. Proceeds from this strategy may be used to purchase equities.
Keywords: Informed trading; intraday trading; short selling; liquidity trading.
Volatility Transmissions Between Commodity Futures Contracts in Short, Medium and Long Term.
by Mathias Schneid Tessmann
Abstract: This article investigates the relationship between agricultural and energy commodity markets by measuring the volatility transmissions between future contracts through a spillover index that can be partitioned into different frequency bands. We use data from Chicago Mercantile Exchange and the Intercontinental Exchange of New York from March 3, 2000 to May 4, 2017, including 10 different commodities. We show that volatility transmissions increased after the 2006-2008 food crisis, but has fallen after 2013. Around 74.4% of the volatility in those markets is transmitted from one to four days since the shock has occurred. Corn, wheat and soybeans are the main transmitters and receivers of volatility, while oil is significantly more important than natural gas in terms of price volatility transmissions.
Keywords: Volatility transmission; Commodities; Futures markets; Energy Assets; Agricultural Assets.