A Copula-Based Autoregressive Conditional Dependence Model of International Stock Markets

This paper investigates the level and development of cross-country stock market dependence using daily returns on stock indices. The use of copulas allows us to build exible models of the joint distribution of stock index returns. In particular, we apply univariate AR(p)-GARCH(1,1) models to the margins with possibly skewed and fat tailed return innovations, while modelling the dependence between markets using parametric families of copulas which offer various alternatives to the commonly assumed normal dependence structure. Moreover, the dependence across stock markets is allowed to vary over time through a GARCH-like autoregressive conditional copula model. Using synchronous daily returns on U.S., U.K., and French stock indices, we find strong evidence that the conditional dependence between pairs of each of these markets varies over time. All market pairs show high levels of dependence persistence. The performance of the copula-based approach is compared with Engle's (2002) dynamic conditional correlation model and found to be superior.stock markets; dependence; copulas; synchronicity

An Anatomy of Futures Returns: Risk Premiums and Trading Strategies

This paper analyzes trading strategies which capture the various risk premiums that have been distinguished in futures markets. On the basis of a simple decomposition of futures returns, we show that the return on a short-term futures contract measures the spot-futures premium, while spreading strategies isolate the term premiums. Using a broad cross-section of futures markets and delivery horizons, we examine the components of futures risk premiums by means of passive trading strategies and active trading strategies which intend to exploit the predictable variation in futures returns. We find that passive strategies which capture the spot-futures premium do not yield abnormal returns, in contrast to passive spreading strategies which isolate the term premiums. The term structure of futures yields has strong explanatory power for both spot and term premiums, which can be exploited using active trading strategies that go long in low-yield markets and short in high-yield markets. The profitability of these yield-based trading strategies is not due to systematic risk. Furthermore, we find that spreading returns are predictable by net hedge demand observed in the past, which can be exploited by active trading. Finally, there is momentum in futures markets, but momentum strategies do not outperform benchmark portfolios.Predictability; futures term structure; hedging pressure

Risk Aversion, Price Uncertainty, and Irreversible Investments

This paper generalizes the theory of irreversible investment under uncertainty by allowing for risk averse investors in the absence of com-plete markets.Until now this theory has only been developed in the cases of risk neutrality, or risk aversion in combination with complete markets.Within a general setting, we prove the existence of a unique critical output price that distinguishes price regions in which it is optimal for a risk averse investor to invest and price regions in which one should refrain from investing.We use a class of utility functions that exhibit non-increasing absolute risk aversion to examine the e ects of risk aversion, price uncertainty, and other parameters on the optimal investment decision.We nd that risk aversion reduces investment, particularly if the investment size is large.Moreover, we nd that a rise in price uncertainty increases the value of deferring irreversible investments.This e ect is stronger for high levels of risk aversion.In addition, we provide, for the rst time, closed-form comparative statics formulas for the risk neutral investor.