134 research outputs found
Inflation Targeting and Exchange Rate Regimes; Evidence from the Financial Markets
Inflation targeting is gaining popularity as a framework for conducting monetary policy. At the same time many countries employ some sort of foreign exchange intervention policy
assuming that these two policies can coexist. This paper attempts to show that both
policies are not sustainable. The potential conflict between the two policies is costly to the economy and will eventually result in the abandonment of one of these policies. Israel is a classic test case for two reasons. First, in the mid to late 90s Israel has struggled to maintain both policies. Second, it has a variety of financial instruments which provide a rich source of information. We test our hypothesis about the conflict using information from the
financial markets. The results support the hypothesis that both policies cannot be
sustained in the long run. The conclusion is that a credible monetary policy aimed at
inflation targets should be conducted in a free floating exchange rate regime
Asset Pricing and Ambiguity: Empirical Evidence
Modern portfolio theory focuses on the relationship between risk and
return, assuming away ambiguity, uncertainty over the probability space.
This paper assumes that ambiguity affects asset prices and tests the
relationship between risk, ambiguity and return based on a model
developed by Izhakian (2011). Its contribution is twofold; it proposes
an ambiguity measure that is derived theoretically and computed from
stock market prices. Second, it uses ambiguity in conjunction with risk
to test the basic relationship between risk, ambiguity and return. This
paper finds that ambiguity has a consistently negative effect on returns
and risk mostly has a positive effect
Pricing Systematic Ambiguity in Capital Markets
Asset pricing models assume that probabilities of future outcomes are
known. In reality, however, there is ambiguity with regard to these
probabilities. Accounting for ambiguity in asset pricing theory results
in a model with two systematic components, beta risk and beta ambiguity.
The focus of this paper is to study the empirical implications of
ambiguity for the cross section of equity returns. We find that
systematic ambiguity is an important determinant of equity returns. We
also find that the Fama-French factors contribute to the explanatory
power of the two main drivers of returns; namely, systematic risk and
systematic ambiguity
Asset Prices and Ambiguity
Modern portfolio theory, developed in the expected utility paradigm,
focuses on the relationship between risk and return, assuming away
ambiguity, uncertainty over the probability space. In this paper, we
assume that ambiguity affects asset prices and we test the relationship
between risk, ambiguity and return based on a model developed by
Izhakian (2011). Our contribution is twofold; we propose an ambiguity
measure that is derived theoretically and computed from intraday stock
market prices. Second, we use it in conjunction with risk measures to
test the basic relationship between risk, ambiguity and return. We find
that our ambiguity measure has a consistently negative effect on returns
and that our risk measure has mostly a positive effect. The best
evidence, judging by statistical significance, is obtained when we use
the change in volatility alongside the measure of ambiguity
Liquidity and Efficiency in Three Related Foreign Exchange Options Markets
The foreign currency market in a small open economy, like Israel, plays a major role in
fiscal and monetary policy decisions, through its effects on the financial markets and the
real economy. In this paper we explore the liquidity and efficiency in three related
foreign exchange options markets and the information content of the instruments traded
in these markets. The unique data set on OTC trading and the central bank auctions, in
addition to the exchange traded options provide us with insights about the operation of these markets, their relative efficiency, their information content and their
interrelationship. An important aspect is the effect of liquidity on the pricing of options in these markets. As expected, we find that, except for extreme cases, liquidity does not
affect options prices
INFLATION EXPECTATIONS DERIVED FROM FOREIGN
Inflation expectations are a key economic variable for investors in capital markets and for economic policy decision makers. One of the widely used sources for deriving inflation expectations are market prices of bonds. The yield differential between nominal bonds and inflation-indexed (linked) bonds is taken to be an estimate of expected inflation. The problem is however that in a risk averse world the yield differential includes an inflation risk premium and thus the yield differential provides an upward bias of inflation expectations. The novelty of our paper is that we estimate this risk premium using volatility implied in options prices. In the absence of a market in options on inflation we use prices of foreign currency options to estimate this risk premium. The theoretical foundation of our methodology is purchasing power parity theory. The Israeli financial market has both, an inflation linked and non linked bond market and an active FX options market. Using data from both markets we find a statistically and economically significant
inflation risk premium
Ambiguity and Overconfidence
There are two phenomena in behavioral finance and economics which are
seemingly unrelated and have been studied separately; overconfidence and
ambiguity aversion. In this paper we are trying to link these two
phenomena providing a theoretical foundation supported by evidence from
an experimental study. We derive a model, based on the max-min ambiguity
framework that links overconfidence to ambiguity aversion. In the
experimental study we find that overconfidence is decreasing in
ambiguity, as predicted by our model
THE PRICE OF OPTIONS ILLIQUIDITY
The purpose of this paper is to examine the effect of illiquidity on the value of currency options. We use a unique data set which allows us to explore this issue in special circumstances where options are issued by a central bank and are not traded prior to maturity. The value of these options is compared to similar options traded on the exchange. We find that the non-tradable options are priced about 21 percent less than the exchange traded options. This gap cannot be arbitraged away due to transactions costs and the risk that the exchange rate will change during the bidding process
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