Optimal investments in volatility

Volatility has evolved as an attractive new asset class of its own. The most common instruments for trading volatility are variance swaps. Mean returns of DAX and ESX variance swaps over the time period of 1995 to 2004 are strongly negative, and only part of the negative premium can be explained by the negative correlation of variance swap returns with stock market indices. We analyze the implications of this observation for optimal portfolio composition. Mean-variance efficient portfolios are characterized by sizable short positions in variance swaps. Typically, the stock index is also sold short to achieve a better portfolio diversification. To capture heterogeneous preferences for higher moments, we use a variant of the polynomial goal programming method. We assume that investors strive for a high Sharpe ratio, high skewness, and low kurtosis. Our analysis reveals that it is often not possible to achieve a balanced tradeoff between Sharpe ratio and skewness. Investors are advised to hold the extreme portfolios (Sharpe ratio driven, skewness driven, or kurtosis driven) and avoid the middle ground. This "all-or-nothing” characteristic is reflected in jumps of asset weights when certain thresholds of preference parameters are crossed. These empirical findings can explain why many investors are so reluctant to implement option-based short-selling strategie

Money-back guarantees in individual pension accounts : evidence from the German pension reform

The German Retirement Saving Act instituted a new funded system of supplementary pensions coupled with a general reduction in the level of state pay-as-you-go old-age pensions. In order to qualify for tax relief, the providers of supplementary savings products must offer a guarantee of the nominal value at retirement of contributions paid into these saving accounts. This paper explores how this "money-back" guarantee works and evaluates alternative designs for guarantee structures, including a life cycle model (dynamic asset allocation), a plan with a pre-specified blend of equity and bond investments (static asset allocation), and some type of portfolio insurance. We use a simulation methodology to compare hedging effectiveness and hedging costs associated with the provision of the money-back guarantee. In addition, the guarantee has important implications for regulators who must find an appropriate solvency system for such saving schemes. This version June 17, 2002 . Klassifikation: G11, G23, G2

Financing practices in the German venture capital industry : an empirical assessment

This paper investigates the financial contracting behavior of German venture capitalists against the results of recent theoretical work on the design of venture capital contracts, especially with regard to the use of convertible securities. First, we identify a special feature of the German market, namely that public-private partnership agencies require significantly lower returns than private and young venture capitalists. The latter are most likely to follow their North-American counterpart by refinancing themselves with closed-end funds. Second, with regard to financing practices it is shown that the use of convertibles, relative to other instruments, is influenced by the anticipated severity of agency problems. Klassifikation: C24; G24; G3

Modelování efektů přelévání volatility

The main goal of this thesis is to investigate, compute and interpret volatility spillover effect in selected European developed stock markets using extended autoregressive conditional volatility models. In particular, there is modelled an impact of volatility coming from US and Eurozone stock markets. For the purpose of this thesis, we utilize daily returns of US, Eurozone, German, French, British and Swiss stock markets covering the period from January 2003 to August 2017. All the stock markets is approximated by main stock indexes. The main goal of this thesis is supported by two sub-goals: the first sub-goal is to model and measure the price spillover effect using VAR models; the second sub-goal is to investigate an impact of global financial crisis on volatility spillover effects. Results confirmed significant impact of the price and volatility spillover effect coming from the US stock market. This effect increased during the global financial crisis.Hlavním cílem této diplomové práce je analýza, kvantifikace a interpretace efektu přelévání volatility na vybraných evropských rozvinutých akciových trzích za použití rozšířených autoregresivních modelů podmíněné volatility. Předně řečeno, v předložené práci bude modelován vliv volatility přicházející z amerického akciového trhu a trhu eurozóny. Pro účely této práce jsou využity denní výnosy amerického, německého, francouzského, britského a švýcarského akciového trhu a také trhu eurozóny v období od ledna 2003 do srpna 2017. Vývoj akciových trhů bude aproximován hlavními akciovými indexy. Hlavní cíl diplomové práce je rozvinut do dvou dílčích cílů. Prvním z nich je modelování a měření také efektů přelévání cenových šoků při využití VAR modelů. Druhý dílčí cíl je analýza vlivu globální finanční krize na efekt přelévání volatility. Dosažené výsledky potvrdily významný vliv efektů volatility z amerického akciového trhu. Tento efekt navíc vzrostl v době globální finanční krize.154 - Katedra financívelmi dobř

Derivative Securities in Germany: An Examination of the Price Discovery and Extreme Value Processes.

This dissertation examines the price discovery and extreme value processes found in Germany\u27s stock index and stock index futures markets. These two concepts are framed within the fundamental relationship between risk and return found in the financial economics literature. Results from the price discovery analysis indicate that the stock index futures market processes information more quickly than the underlying spot market. However, this processing can be characterized by a feedback loop because sometimes the spot market processes information more quickly than the futures market. An indepth analysis of the information processing relationship implies that the futures market processes information faster than most of the individual stock index component stocks. However, two securities sometimes lead the futures market. The reasons these two securities lead the futures market are of particular interest. Additionally, the processing speed of the futures market tends to be increased when there is market-wide, as opposed to security-specific, information affecting the securities market. Also, analyses of up and down markets and different trading activity proxies are performed. They reveal that the lead-lag relation is conditional on the information set available to market participants. The results of the extreme value section indicate that extreme price declines for most FDAX contracts are larger in absolute terms than extreme price increases. The results of the extreme value analysis also indicate that the data generation process of the extreme price changes originate from a Type II extreme value process. An examination of prudent margin setting procedures is made as a practical application of extreme value theory. The results of this part of the study indicate that the extreme value distribution approximates the empirical extreme value observations better than the normal distribution process

The Swiss black swan bad scenario: is Switzerland another casualty of the Eurozone crisis

Financial disasters to hedge funds, bank trading departments and individual speculative traders and investors seem to always occur because of non-diversification in all possible scenarios, being overbet and being hit by a bad scenario. Black swans are the worst type of bad scenario: unexpected and extreme. The Swiss National Bank decision on January 15, 2015 to abandon the 1.20 peg against the euro was a tremendous blow for many Swiss exporters, but also Swiss and international investors, hedge funds, global macro funds, banks as well as the Swiss central bank. In this paper we discuss the causes for this action, the money losers and the few winners, what it means for Switzerland, Europe and the rest of the world, what kinds of trades lost and how they have been prevented

Anatomy of the portuguese stock market risk and return in the 1977-2012 period

This paper analyses the Portuguese stock market since it reopened in 1977, with a special focus on the evolution of the statistic and stochastic characteristics of the market return throughout this 36 year period. The market return for the period of time between 1977 and 2012 (September 28th) is estimated and then compared with the return that would have been achieved with Government bonds and treasury bills, which allows us to confirm that the hierarchy of return / risk across the different financial instruments is verified. The market risk premium for this 36 year period is also estimated and a comparison with other markets is performed, suggesting that the Portuguese market’s risk has not been compensated by an adequate return. The study also examines the evolution of the Portuguese market’s volatility in the 1977-2012 period and compares it with other markets, showing the existence of extremely high peaks during the first 11 years, but indicating a downwards trend throughout the whole period under analysis. Finally, the correlation between market returns for Portugal and for other countries and the degree of integration are estimated and their evolution throughout time is assessed, leading to the conclusion that the performance of the Portuguese stock market has become increasingly correlated with major European markets – correlation with some markets close to 0.70 from 2000 onwards-, but that country-specific risk factors are still relevant

Range-based Risk Estimation in Euro Area Countries

This dissertation considers a range of topics on the use of range-based risk estimators for financial markets (with the exception of Chapter 5 discussed below). Chapter 1 provides an introduction to the existing literature and the research objectives of the dissertation. Chapter 2 uses time series of daily high-low ranges of national equity market indices to analyse daily volatility dynamics and volatility spillover across four European markets. Chapter 2 is based on the joint research with Gregory Connor. We develop a dynamic linear model of expected daily range which is a variant of Chou’s conditional autoregressive range model. We find significant, but not uniform, range-based volatility spillovers. During the crisis period (after July 2007) we find significant increases in daily range, increases in contemporaneous correlation, and increases in the influence of previous-day US market range on the conditional expected range of these European markets. A gamma-distribution-based model of realized daily range fits more closely than one based upon a Feller distribution, but it sacrifices the link to a specific distribution for underlying returns. In Chapter 3 we use information on the daily opening, close, high, and low prices of individual stocks to estimate range-based correlation and to construct a new estimator of market betas. We create a measure called “range-beta”, which is based on the daily range-based volatility and covariance estimators of Rogers and Zhou (2008). These range-based betas reflect the current day’s intra-day price movements. They avoid a weakness of return based betas, which typically are based on close-to-close returns. Our approach yields competitive estimates compared with traditional methodologies, and outperforms other methodologies when analysing highly liquid assets. Chapter 4 studies the relationship between options-implied and realized-range-based volatility estimates for Euro area countries. When both implied volatility and historical range-based volatility are used to forecast realized range-based volatility, we find that implied volatility outperforms historical range-based volatility. We also find that the stochastic volatility is priced with a negative market price of risk. The volatility implied from option prices is higher than the realized range-based volatility under the objective measure due to investor risk aversion. Chapter 5 considers financial market risk from a different perspective. Chapter 5 analyses the tone and information content of the two external policy reports of the Internal Monetary Fund (IMF), the IMF Article IV Staff Reports and Executive Board Assessments, for Euro area countries. In particular, we create a tone measure denoted WARNING, based on the existing DICTION 5.0 Hardship dictionary. We find that in the run-up to the current credit crises, average WARNING tone levels of Staff Reports for Slovenia, Luxembourg, Greece, and Malta are one standard deviation above the EMU sample mean; and for Spain and Belgium, they are one standard deviation below the mean value. Furthermore, on average for Staff Reports over the period 2005-2007, there are insignificant differences between the EMU sample mean and Staff Reports’ yearly averages. We also find the presence of a significantly increased level of WARNING tone in 2006 for the IMF Article IV Staff Reports. There is also a systematic bias of WARNING scores for Executive Board Assessments versus WARNING scores for the Staff Reports