The Cross Sectional Dependence Puzzle

The analysis of unit roots and cointegration in panel data is becoming a growing research area. A number of issues have been raised in the literature (see Phillips and Moon 1999 and 2000, Banerjee 2000, Maddala and Wu 1999). The aim of the present paper is to contribute to the issue of cross sectional dependence in non-stationary panel data. We review some of the most recent econometric techniques proposed by the literature to dealing with cross sectional dependence and notice a sort of puzzle. We extend the bootstrap methodology proposed by Maddala and Wu (1999) and apply the resulting test to test for PPP. We find no evidence favouring PPP. Finally, we use Monte Carlo simulation to analyse the size distortion of the bootstrap test presented in this paper. The proposed test presents size distortion only when T = 100.

Valuing American Derivatives by Least Squares Methods

Least Squares estimators are notoriously known to generate sub-optimal exercise decisions when determining the optimal stopping time. The consequence is that the price of the option will be underestimated. We show how to use variance reduction techniques to extend some recent Monte Carlo estimators for option pricing and assess their performance in finite samples. Finally, we extend the Longstaff and Schwartz (2001) method to price American options under stochastic volatility. This is the first study to implement and apply the Glasserman and Yu (2004b) methodology to price Asian options and basket options.American options, Monte Carlo method

The rise and fall of the ABS market

The financial crisis has raised some concern about the quality of information available on some traded assets on the securities markets to market participants and regulators. Asset-backed securitization in general got partial blame for the paucity of liquidity on bank balance sheets and the consequent credit crunch. After the Asset-Backed Security (ABS) market fell to near inactivity in 2009, the US federal government's Term Asset-Backed Securities Loan Facility (TALF) provided backing and a boost to the issuance of asset-backed securitization. In this market condition, given the nature of ABS, it is difficult for them not to be relatively illiquid, and this has resulted in unacceptable levels of market risk for most investors. Their liquidity before the crisis was driven by a market in continuous expansion, fed by Special Purpose Vehicle (SPV), Conduits, and other low capitalized term-transformation vehicles. Nowadays, the industry is concerned with the ongoing ABS reforms and how these will be implemented. This article reviews the ABS market in the last decade and the possible consequences of the recent regulatory proposals. It proposes a retention policy and the institution of a new financial body to supervise the quality of the security in an ABS pool, its liquidity, and the model risk implied by the issuer's valuation modeAsset Backed Security; Government Policy and Regulation

Black market and official exchange rates: Long-run equilibrium and short-run dynamics

This paper provides further empirical results on the relationship between black market and official exchange rates in six emerging economies (Iran, India, Indonesia, Korea, Pakistan, and Thailand). First, it applies both time series techniques and heterogeneous panel methods to test for the existence of a long-run relation between these two types of exchange rates. Second, it tests formally the validity of the proportionality restriction implying a constant black-market premium. Third, in addition to the long-run equilibrium, it also analyses the short-run dynamic responses of both markets to shocks. Evidence of market inefficiency and incomplete (or long-lived) reversion to long-run equilibrium is found. This implies that financial managers can only partially reduce the exchange rate risk, whilst monetary authorities can effectively pursue their policy objectives by imposing foreign exchange or direct controls

Valuing American Put Options Using Chebyshev Polynomial Approximation

This paper suggests a simple valuation method based on Chebyshev approximation at Chebyshev nodes to value American put options. It is similar to the approach taken in Sullivan (2000), where the option`s continuation region function is estimated by using a Chebyshev polynomial. However, in contrast to Sullivan (2000), the functional is fitted by using Chebyshev nodes. The suggested method is flexible, easy to program and efficient, and can be extended to price other types of derivative instruments. It is also applicable in other fields, providing efficient solutions to complex systems of partial differential equations. The paper also describes an alternative method based on dynamic programming and backward induction to approximate the option value in each time period

Dynamic option adjusted spread and the value of mortgage backed securities

We extend a reduced form model for pricing mortgage-backed securities (MBS) pass through and provide a novel hedging tool for investors in this market. To calculate the price of an MBS traders use what is known as option-adjusted spread (OAS). The resulting OAS value represents the required basis points adjustment to reference curve discounting rates needed to match an observed market price. The OAS suffers from some drawbacks. For example, it remains constant until the maturity of the bond (thirty years in mortgage-backed securities), and does not incorporate interest rate volatility. We suggest instead what we call dynamic option adjusted spread (DOAS). The latter allows investors in the mortgage market to account for both prepayment risk and changes of the slope of the yield curve

Customizing Data-plane Processing in Edge Routers

While OpenFlow enables the customization of the control plane of a router, currently no solutions are available for the customization of the data plane. This paper presents a prototype that offers to third parties (even end-users) the possibility to install their own applications on the data plane of a router, particularly the ones operating at the edge of the network. This paper presents the motivation of the idea, the reason why we use OpenFlow even if it does not seem appropriate for the data plane, the architecture and the implementation of our prototype, and a first characterization of the system running in our la

Panel Data Tests Of PPP: A Critical Overview

This paper reviews recent developments in the analysis of non-stationary panels, focusing on empirical applications of panel unit root and cointegration tests in the context of PPP. It highlights various drawbacks of existing methods. First, unit root tests suffer from severe size distortions in the presence of negative moving average errors. Second, the common demeaning procedure to correct for the bias resulting from homogeneous cross-sectional dependence is not effective; more worryingly, it introduces cross-correlation when it is not already present. Third, standard corrections for the case of heterogeneous cross-sectional dependence do not generally produce consistent estimators. Fourth, if there is between-group correlation in the innovations, the SURE estimator is affected by similar problems to FGLS methods, and does not necessarily outperform OLS. Finally, cointegration between different groups in the panel could also be a source of size distortions. We offer some empirical guidelines to deal with these problems, but conclude that panel methods are unlikely to solve the PPP puzzl

Dynamic Option Adjusted Spread and the Value of Mortgage Backed Securities

We extend a reduced form model for pricing pass-through mortgage backed securities (MBS) and provide a novel hedging tool for investors in this market. To calculate the price of an MBS, traders use what is known as option-adjusted spread (OAS). The resulting OAS value represents the required basis points adjustment to reference curve discounting rates needed to match an observed market price. The OAS suffers from some drawbacks. For example, it remains constant until the maturity of the bond (thirty years in mortgage-backed securities), and does not incorporate interest rate volatility. We suggest instead what we call dynamic option adjusted spread (DOAS). The latter allows investors in the mortgage market to account for both prepayments risk and changes of the yield curve.Asset pricing, Mortgage Backed Securities, Term Structure Ambiguity, arrival rate of innovation, R&D investments.