4,342 research outputs found

    Pricing Options with Portfolio-based Option Trading Agents in Direct Double Auction

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    Options constitute integral part of modern financial trades, and are priced according to the risk associated with buying or selling certain asset in future. Financial literature mostly concentrates on risk-neutral methods of pricing options such as Black- Scholes model. However, using trading agents with utility function to determine the option’s potential payoff is an emerging field in option pricing theory. In this paper, we use one of such methodologies developed by Othman and Sandholm to design portfolioholding agents that are endowed with popular option portfolios such as bullish spread, bearish spread, butterfly spread, straddle, etc to price options. Agents use their portfolios to evaluate how buying or selling certain option would change their current payoff structure. We also develop a multi-unit direct double auction which preserves the atomicity of orders at the expense of budget balance. Agents are simulated in this mechanism and the emerging prices are compared to risk-neutral prices under different market conditions. Through an appropriate allocation of option portfolios to trading agents, we can simulate market conditions where the population of agents are bearish, bullish, neutral or non-neutral in their beliefs

    Financial market liquidity and the lender of last resort.

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    In the summer 2007, difficulties in the US subprime mortgage markets have led to disruptive developments in many financial market segments, in particular in interbank money markets, where central banks in the US and in Europe repeatedly intervened to restore smooth market functioning. This article investigates the circumstances in which liquidity shortages may appear in fi nancial markets and evaluates a number of options available to the lender of last resort wishing to restore fi nancial stability. It also suggests that the consideration of balance sheet data is not sufficient for evaluating the risks of leveraged financial entities. Instead, the analysis calls for an explicit consideration of collateral pledges, market illiquidity, and potential non-availability of market prices. Our main messages can be summarised as follows. First, we provide a clear hierarchy across policy alternatives. Taking a risk-efficiency perspective, it turns out that targeted liquidity assistance is preferable to market-wide non-discriminatory liquidity injections. In particular, when liquidity may be alternatively used for speculative purposes during the crisis, non-discriminating open market operations may attract unfunded market participants that divert funding resources away from its best uses in the financial sector. As a consequence, targeted liquidity assistance may become strictly superior. Second, we suggest that forced asset sales may lead to disruptive market developments in a context where financial investors are highly leveraged. Assuming away external funding or renegociability of debt contracts, a fully leveraged investor hit by a liquidity shock would have to liquidate some assets. When markets are not perfectly liquid, asset liquidation depresses market prices. Under standard risk management constraints, lower prices induce a re-evaluation of marked-to-market balance sheets, provoke margin calls, and trigger further selling. In the worst scenario, the leveraged investor may not be able to face the sum of liquidity outfl ows and subsequent margin calls. In that case, the market for illiquid assets breaks down, rendering the valuation of such assets an ambiguous exercise. For investors, such potential trading disruptions imply that the loss that triggers operational default is likely to be much smaller than suggested by standard risk measures.

    Decision-making and the role of feedback in complex tasks

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    This thesis investigates the process of decision-making in relation to complex tasks and considers the important role which dynamic information and real-time feedback play in shaping response behaviour and adaptation within such environments. Through empirical studies, the thesis explores the extent to which decision-makers can be said to act rationally when challenged by complex decision-making environments. Evidence relating to demand for information and the impact of feedback on behaviour is provided with two studies: The first uses a simulated auction platform to examine behaviour within overlapping auctions of short duration with close-to-identical items and minimal participation costs. Mouse tracking is used to capture data on relevant interactions of participants with the simulated online platform, including switching behaviour independent of bidding. The resulting data suggests that participants did behave in a manner consistent with utility maximisation, seeking to acquire the item at the lowest possible price and showing no bias in terms of auction preference. The impact of fixed-price offers in the form of a “Buy it Now” option is also examined with some evidence that participants again seek, and respond to, current information when deciding on their bidding strategy. The second study is a test of the impact of real-time feedback and demand for information within the context of financial markets. The study again uses a novel simulated environment which provides access to considerable amounts of relevant data which participants can choose to access. In addition, participants are exposed to regular feedback with regard to their own performance. Overall, demand for information is found to be dependent upon the type of feedback received and its context. Decision-makers then appear to behave objectively, apparently seeking the latest available information to support current decisions, although investor style is found to be important in determining overall trading propensity. The thesis starts by considering a number of the foundations and pathways which run through the judgment and decision-making literature. It is not a complete description, review or analysis of all of the prevailing lines of enquiry. Nevertheless, it seeks to achieve coherence in terms of bringing together some of the key themes dealing with risky choice under conditions of uncertainty and ambiguity. The field of judgment and decision-making is inevitably vast; its scope owing much to the fact that it transcends individual disciplines. The emergent behavioural sciences thus draw together important strands from various sources, notably Economics and Finance. In many areas, psychological traits can be applied to explain inconsistencies which are found in classical theory of rational behaviour. The recognition of behavioural traits has thus contributed greatly to the evolution of decisionmaking theories under conditions of uncertainty and ambiguity which are, in many cases, substantially more adaptable and robust than early normative theories of rational behaviour. The classical approach to rational decision making within Economics, together with some theoretical and empirical challenges to it, are considered in Chapter 1. It is here that we are introduced to the Rational Man. Like the mythical creatures found in Classical Antiquity, the Rational Man does not actually exist in the real world; he is nevertheless central to the concept of utility maximising rational choice which provided much of the foundation of Economics. Developments of expected utility theory (EUT) are considered, including its replacement of expected value, and the formalisation of rational behaviour within the context of axioms. When those logical axioms apply, decision-makers can be said to behave 'as if' they are utility maximises. The chapter ends with some empirical evidence, showing the types of approaches often used to explore rational decision-making. Some violations of EUT are explored, both in relation to notional gambles and consistency with regard to revealed preferences. Chapter 2 extends the narrative by considering rational decision-making in cases where there is no objective information about possible outcomes. Subjective utility theory (SEU) is then introduced, describing objective functions based upon preferences derived from combined utility and probability functions. The implications of the Allais’ and Ellsberg paradoxes are discussed, along with some possible solutions. It is here that we explore the concepts of uncertainty and ambiguity in more details and consider some theoretical formulations for addressing them. Chapter 3 covers the significant contribution to decision-making under conditions of uncertainty provided by Prospect Theory and, later, Cumulative Prospect Theory (CPT). Their evolution from the pioneering work of Markowitz is discussed within the context of reference points relative to which outcomes can be evaluated. The significance of stochastic dominance and rank dependence are explored. By this stage, we have examined numerous theories which have fundamentally transformed standard EUT into much more flexible and adaptable frameworks of rational choice. The core concepts of utility maximisation remain yet the initial, strictly concave utility function describing diminishing marginal utility is now substantially replaced by more complex weighted preference functions. From this theoretical base, the process of choice reduction and the application of heuristics in decision-making are considered. We again describe axiomatic behaviour compatible with rational choice. Therefore, decision-makers faced with multiple choices about which there may be little or no objective information about likely outcomes can nevertheless develop rational beliefs and expectations which can then be applied to reduce complex tasks to more manageable proportions. As well as considering these aspects from the point of view of actual choices, we also consider the processes by which decisions are taken. Thus, process tracing methods are introduced into the discussion. The chapter also explicitly considers the role of feedback in decision making. This includes a consideration of Bayesian inference as a process for updating probabilistic expectations subject to new information. From considering theoretical formulations form which we can judge rational behaviour, Chapter 5 looks at evidence for sub-optimal decision-making and bias. Bias with regard to probability assessments are considered along with empirical evidence of bias in relation to intertemporal discounting. Sunk cost bias is also considered as a clear example of irrational behaviour, leading in to a specific discussion about a number of persistent behavioural biases identified within financial markets. As an introduction to later chapters, this also covers the basic theoretical principles of market efficiency and evidence that real markets fail to adhere to those principles in important ways. Chapters 6 and 8 describe the empirical studies with Chapter 7 providing a more detailed introduction to the financial markets experiment, considering aspects of market efficiency, models of behaviour and other empirical evidence

    Issues in pricing, liquidity, information efficiency, asymmetric information and trading sysyems

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    Market microstructure is a relatively new area in finance which emerged as a result of inconsistency between actual and expected prices due to a variety of frictions (mainly trading frictions and asymmetric information) and the realisation that the trading process through which investors' demand is ultimately translated into orders and volumes is of greater importance in price formation than it was originally thought. Despite increased research in the area of liquidity, asset pricing, asymmetric information and trading systems, all subfields in the area of market microstructure, there are a number of questions that remain unanswered such as the effect of different trading systems on systematic liquidity, informational efficiency or components of the spread. This thesis aims at shedding light on those questions by providing a detailed empirical investigation of the effect of trading systems on systematic liquidity, pricing, informational efficiency, volatility and bid-ask spread decomposition mainly with respect to the UK market (FTSEIOO and FTSE250) and to a less extent with respect to the Greek market. Those two markets are at different levels of development/sophistication and are negatively correlated.The aims of this thesis are outlined in chapter one with chapter two providing a detailed review of the theoretical literature relevant to this study. Chapter three is the first empirical chapter and tests for the presence of a common underlying liquidity factor (systematic liquidity) and its effect on pricing for FTSE100 and FTSE250 stocks under different trading regimes. Results show the presence of commonality for FTSE100 and FTSE250 stocks although commonality is weaker for FTSE250 stocks and its role on pricing is reduced. Chapter four investigates the same issues with respect to the Greek market and we find that commonality appears to be stronger in some periods while it is reduced to zero for other periods. Chapter five focuses on the effect that changes in the trading systems can have on informational efficiency and volatility primarily with respect to FTSE100 and FTSE250. Different methodologies and data are employed for this purpose and produce similar results. We find that order driven markets are more responsive to incoming information when compared to quote driven markets. Volatility has a greater impact on the spread when the market is quote driven. We also examined if automated trading increased informational efficiency with respect to the Greek market. The results obtained indicated that the effect of automation was positive. Finally the last chapter focused on the effect of different trading systems on the components of the spread and their determinants. Our main finding is that the asymmetric component of the spread is higher under a quote driven market. Also stock volatility appears to affect the asymmetric component to a greater extent when the market is quote driven. We believe that the main justification for those findings is affirmative quotation

    Alternative Pricing and Delivery Strategies for Alberta Cattle Feeders

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    This study evaluates the risk and returns to cattle feeding in Alberta from the application of alternative marketing and pricing strategies. Feedlot finishing of 650 pound calves and 800 pound yearlings is modeled over the years from 1980 to 1993. The results of the study are based on the domestic and US marketing of live cattle using traditional cash marketing, futures contracts, put options, and forward production contracting systems. Use of the Western Domestic Feed Barley contract is also simulated. The results showed that barley price changes produced relatively small return changes compared to feeder and fat cattle price changes. An important source of return risk was found to be basis risk. Production contracting strategies which eliminated basis risk were found to provide the best returns in a market based risk-return comparison. The use of put options did not add value to cattle feeding investments.Demand and Price Analysis, Marketing,

    The challenge for liquidity in small stock exchanges and trading portals : the case of the Belgian Stock Exchange

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    Thesis (M.B.A.)--Massachusetts Institute of Technology, Sloan School of Management, 2005.Includes bibliographical references (leaves 52-53).The world-wide consolidation in the electronic trading industry has provided evidence that small exchanges and trading portals need to deliver more than sophisticated technology, streaming quotes and market data. In order to deliver value and survive, they need to provide liquidity. Noteworthy among the most recent industry challenges is the dismal performance of exchanges like the Belgian Stock Exchange that finally caved in to the inevitable merger with the London Stock Exchange. The Italian exchange took similar action and so did a number of other small exchanges in the European Union. This development has exacerbated the debate over the need for small stock exchanges and portals to exist unless they can provide both superior technology and liquidity. This paper proposes to examine the performance of the Belgian stock exchange and a select group of portals trading Belgian equities through the metric of liquidity access for fostering trade execution and capital flows. Illiquidity and the dislocation of a number of securities traded on the Belgian exchange are examined using transaction costs and the price impact of trading (as opposed to just asset prices) to explain such lack of liquidity.Concurrently, the intervention of aggregators of liquidity pools and the rising influence of noise traders (hedge funds) are analyzed to provide a framework for understanding the mechanisms used to attract liquidity. This serves to determine whether portals may continue to attract large pools of liquidity. In closing, we suggest that capital assets are probably not mispriced in markets served by small exchanges, and thus arbitrage opportunities do not exist. Other factors related to timing, anticipation effects and outliers are more significant in determining whether liquidity providers initiate in those markets. The nature of the economies that these exchanges are designed to support is also a contributing factor to the dislocation and disintermediation of capital demand from local firms and truly large global organizations.by Steven E. Goune.M.B.A

    The relevance of index funds for pension investment in equities

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    The rise of index funds over the past 25 years has been a remarkable phenomenon. The traditional rationale for the success of index funds is market efficiency, net of transaction costs. The authors also focus on the role of agency conflicts between fund managers and investors, which are hard to resolve, given the low power of statistical tests of performance. Most of the empirical evidence about the superiority of index funds comes from the United States. The authors discuss issues associated with the application of index funds in developing countries, as well as policy issues in the financial sector that affect the enabling market infrastructure for index funds. They also apply these ideas to thinking about the relevance of index funds for pension investment. The equity premium provides powerful motivation for equity investment by pension funds. Index funds make it possible to sidestep the complexities of forming contracts and monitoring institutions to govern fund managers. In developing countries that seek to use index funds in pension investment, there are avenues through which policymakers can make index funds more viable. In many countries there are significant avenues for improving construction of the market index as well as market mechanisms used in the equity market.Agricultural Knowledge&Information Systems,Payment Systems&Infrastructure,Economic Theory&Research,Markets and Market Access,Access to Markets
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