A generalized algorithm for duration and convexity of option embedded bonds

This article derives a generalized algorithm for duration and convexity of option embedded bonds that provides a convenient way of estimating the dollar value of 1 basis point change in yield known as DV01, an important metric in the bond market. As delta approaches 1, duration of callable bonds approaches zero once the bond is called. However, when the delta is zero, the short call is worthless and duration of callable will be equal to that of a straight bond. On the other hand, the convexity of a callable bond follows the same behaviour when the delta is 1 as shown in Dunetz and Mahoney (1988) as well as in Mehran and Homaifar’s (1993) derivations. However, in the case when delta is zero, the convexity of a callable bond approaches zero as well, which is in stark contrast to the non-zero convexity derived in Dunetz and Mahoney’s paper. Our generalized algorithm shows that duration and convexity nearly symmetrically underestimate (overestimate) the actual price change by 11/10 basis points for ± 100 basis points change in yield. Furthermore, our algorithm reduces to that of MH for convertible bonds assuming the convertible bond is not callable.     

Variance and lower partial moment betas as bases for costing equity capital among regulated utilities

An important question in the setting of public utility rates is, ‘What constitutes a fair rate of return or cost of equity capital for a regulated utility?’ Recent debates over this issue have centred on the CAPM's ability to produce realistic equity cost figures for use in the rate-setting process. Several researchers recommend modified or expanded versions of the market model as a means of improving its predictive capabilities. One such approach is the lower partial moment model. The purpose of the present paper is to assess the robustness of the lower partial moment model relative to the conventional CAPM as a basis for estimating the cost of a utility company's equity capital. The hypothesis that empirical estimates of the LPM beta tend to overestimate the true systematic risk of utility companies was corroborated by our test results.     

Exchange rate uncertainty and the efficiency of the forward market for foreign exchange

Exchange Rate Uncertainty and the Efficiency of the Forward Market for Foreign Exchange. — The paper investigates to what extent exchange rate uncertainty can account for the observed deviations from the forward market efficiency hypothesis (FMEH). The empirical analysis employs a simple varying parameter regression to allow uncertainty to modify the central parameters of the FMEH in a direct way. Uncertainty is proxied by significant exchange rate changes. The results indicate that there is considerable support for the FMEH if one allows the intercept term to vary over time.