QUADRATIC TERM STRUCTURE MODELS FOR RISK-FREE AND DEFAULTABLE RATES

In this paper, quadratic term structure models (QTSMs) are analyzed and characterized in a general Markovian setting. The primary motivation for this work is to find a useful extension of the traditional QTSM, which is based on an Ornstein–Uhlenbeck (OU) state process, while maintaining the analytical tractability of the model. To accomplish this, the class of quadratic processes, consisting of those Markov state processes that yield QTSM, is introduced. The main result states that OU processes are the only conservative quadratic processes. In general, however, a quadratic potential can be added to allow QTSMs to model default risk. It is further shown that the exponent functions that are inherent in the definition of the quadratic property can be determined by a system of Riccati equations with a unique admissible parameter set. The implications of these results for modeling the term structure of risk-free and defaultable rates are discussed.     

Replicating portfolio approach to capital calculation

The replicating portfolio (RP) approach to the calculation of capital for life insurance portfolios is an industry standard. The RP is obtained from projecting the terminal loss of discounted asset–liability cash flows on a set of factors generated by a family of financial instruments that can be efficiently simulated. We provide the mathematical foundations and a novel dynamic and path-dependent RP approach for real-world and risk-neutral sampling. We show that our RP approach yields asymptotically consistent capital estimators if the chaotic representation property holds. We illustrate the tractability of the RP approach by three numerical examples.     

Globalization,Worker Mobility and Wage Inequality

In the present paper, I integrate frictional labor markets with on‐the‐job search into an otherwise standard heterogeneous firm model of intra‐industry trade. Most importantly, I show that the returns to workers' inter‐firm mobility are higher in a trade equilibrium than in autarky. Intuitively, by favoring large and productive firms, international trade amplifies the disparities in profitability between small and large firms. Hence, the returns to labor reallocation across firms rise. In view of the empirically observed higher inter‐firm mobility among high‐skill workers, this suggests a skill‐biased impact of trade liberalization.     

Emerging markets before the 1997 Asia Pacific financial crisis

This study investigates which Asia Pacific markets were driven by the US stock market and which by the Japanese stock market during the 1995-97 period, right before the 1997 Asia Pacific financial crisis. The results show that stock markets of Hong Kong, Indonesia and Malaysia shared a long-run equilibrium relationship with the US stock market. The stock market of the Philippines was linked with both the US stock market and the Japanese stock market, while stock markets of Thailand and South Korea did not appear to be influenced by either. Countries whose capital markets had a co-integrating relationship with the US market pegged their national currencies closely to the US dollar.     

Managed Futures for Long‐Term Investors: A DEA Ranking Analysis

This study proposes an alternative Data Envelopment Analysis ranking model to evaluate the relative performance efficiency of commodity‐trading advisors. I measure the performance efficiency using the decision‐making process quality/trading skills framework and depart from the traditional risk–return framework. The Data Envelopment Analysis rankings produced some interesting results. First, similarly to the previous studies, I successfully isolated two ‘superstar’ commodity‐trading advisors with the highest Sharpe ratios as the Grade A commodity‐trading advisors. However, as an improvement over the similar studies that used the traditional risk–return framework, I also isolated two commodity‐trading advisors with average and below‐average Sharpe ratios as Grade A commodity‐trading advisors.     

Destination Attractiveness Drivers among Urban Hostel Tourists: An Analysis of Frustrators and Delighters

This study is based on data from 679 tourists staying at hostel accommodation facilities in Zagreb, a propulsive city‐break destination in Central Europe. Besides providing insight into the socio‐demographic and behavioural characteristics of hostel tourists, this study uncovers determinant destination attributes influencing their perceptions of destination attractiveness. In particular, impact asymmetry analysis identified potential sources of delight and frustration among hostel tourists. Since the hostel tourist segment, as such, is almost completely unconsidered in contemporary tourism research, partly covered only by a few studies on youth travellers and backpackers, the results of this case study are valuable to both practitioners and researchers related to the hostelling industry and city destination marketing organizations. Copyright © 2015 John Wiley & Sons, Ltd.     

Existence of Lévy term structure models

Lévy driven term structure models have become an important subject in the mathematical finance literature. This paper provides a comprehensive analysis of the Lévy driven Heath–Jarrow–Morton type term structure equation. This includes a full proof of existence and uniqueness in particular, which seems to have been lacking in the finance literature so far.      

Fed funds futures variance futures

We develop a novel contract design, the fed funds futures (FFF) variance futures, which reflects the expected realized basis point variance of an underlying FFF rate. The valuation of short-term FFF variance futures is completely model-independent in a general setting that includes the cases where the underlying FFF rate exhibits jumps and where the realized variance is computed by sampling the FFF rate discretely. The valuation of longer-term FFF variance futures is subject to an approximation error which we quantify and show is negligible. We also provide an illustrative example of the practical valuation and use of the FFF variance futures contract.     

Option pricing with orthogonal polynomial expansions

We derive analytic series representations for European option prices in polynomial stochastic volatility models. This includes the Jacobi, Heston, Stein–Stein, and Hull–White models, for which we provide numerical case studies. We find that our polynomial option price series expansion performs as efficiently and accurately as the Fourier‐transform‐based method in the nested affine cases. We also derive and numerically validate series representations for option Greeks. We depict an extension of our approach to exotic options whose payoffs depend on a finite number of prices.     

CONSISTENT MARKET EXTENSIONS UNDER THE BENCHMARK APPROACH

The existence of the growth optimal portfolio (GOP), also known as the Kelly portfolio, is vital for a financial market to be meaningful. The GOP, if it exists, is uniquely determined by the market parameters of the primary security accounts. However, markets may develop and new security accounts become tradable. What happens to the GOP if the original market is extended? In this paper we provide a complete characterization of market extensions which are consistent with the existence of a GOP. We show that a three fund separation theorem applies for the extended GOP. This includes, in particular, the introduction of a locally risk free security, the savings account. We give necessary and sufficient conditions for a consistent exogenous specification of the prevailing short rates.