International index funds and the investment portfolio

Financial advisors often recommend that investors diversify their investments internationally and also use mutual funds with the lowest expenses. Recently it has been possible to use both of these strategies by purchasing an international index fund. This study considers international index funds as a means of portfolio diversification. Performance is evaluated using monthly return data on nine international indexes from January 1989 through December 1997. Returns are measured against the S & P 500 index returns. The results of statistical tests suggest that international index investing does not offer superior returns compared to the S & P 500 index but diversification benefits do exist.     

Empirical pricing kernels

This paper investigates the empirical characteristics of investor risk aversion over equity return states by estimating a time-varying pricing kernel, which we call the empirical pricing kernel (EPK). We estimate the EPK on a monthly basis from 1991 to 1995, using S&P 500 index option data and a stochastic volatility model for the S&P 500 return process. We find that the EPK exhibits counter cyclical risk aversion over S&P 500 return states. We also find that hedging performance is significantly improved when we use hedge ratios based the EPK rather than a time-invariant pricing kernel.     

Can we forecast the implied volatility surface dynamics of equity options? Predictability and economic value tests

We examine whether the dynamics of the implied volatility surface of individual equity options contains exploitable predictability patterns. Predictability in implied volatilities is expected due to the learning behavior of agents in option markets. In particular, we explore the possibility that the dynamics of the implied volatility surface of individual stocks may be associated with movements in the volatility surface of S&P 500 index options. We present evidence of strong predictable features in the cross-section of equity options and of dynamic linkages between the volatility surfaces of equity and S&P 500 index options. Moreover, time-variation in stock option volatility surfaces is best predicted by incorporating information from the dynamics in the surface of S&P 500 options. We analyze the economic value of such dynamic patterns using strategies that trade straddle and delta-hedged portfolios, and find that before transaction costs such strategies produce abnormal risk-adjusted returns.     

Stock selection based on Morningstar’s ten-year,five-star general equity mutual funds

Recent research suggests that the individual investor can build stock portfolios that outperform broad market indices. Based on this research and on evidence supporting the persistence of mutual fund performance, we test whether or not the individual investor can build market-superior portfolios from stocks selected from the top holdings of Morningstar’s ten-year, five-star general equity mutual funds. We use modern portfolio theory to construct the portfolios. Although the portfolios tend to outperform the S&P 500 for the 1990s, we conclude that the evidence is not strong enough to recommend this stock selection strategy to the individual investor.     

A Non-Parametric Option Pricing Model: Theory and Empirical Evidence

In this paper, we propose an empirically-based, non-parametric option pricing model to evaluate S&P 500 index options. Given the fact that the model is derived under the real measure, an equilibrium asset pricing model, instead of no-arbitrage, must be assumed. Using the histogram of past S&P 500 index returns, we find that most of the volatility smile documented in the literature disappears.     

The S&P500 index effect reconsidered: Evidence from overnight and intraday stock price performance and volume

This study focuses on S&P500 inclusions and deletions, examining the impact of potential overnight price adjustment after the announcement of an S&P500 index change. We find evidence of a significant overnight price change that diminishes the returns available to speculators although there are still profits available from the first day after announcement until a few days after the actual event. More importantly, observing the tick-by-tick stock price performance and volume effects on the key days during the event window for the first time, we find evidence of consistent trading patterns during trading hours. A separate analysis of NASDAQ and NYSE listed stocks allows for a detailed examination of the price and volume effect at an intra-day level. We find that index funds appear to cluster their rebalancing activities near to and after the close on the event date, suggesting that they are more concerned with tracking error than profit.     

Pinning in the S&P 500 futures

We show that Standard & Poor's (S&P) 500 futures are pulled toward the at-the-money strike price on days when serial options on the S&P 500 futures expire (pinning) and are pushed away from the cost-of-carry adjusted at-the-money strike price right before the expiration of options on the S&P 500 index (anti-cross-pinning). These effects are driven by the interplay of market makers' rebalancing of delta hedges due to the time decay of those hedges as well as in response to reselling (and early exercise) of in-the-money options by individual investors. The associated shift in notional futures value is at least $115 million per expiration day.     

Strategic trading by index funds and liquidity provision around S&P 500 index additions

We examine the trades of index funds and other institutions around S&P 500 index additions. We find index funds begin rebalancing their portfolios with the announcement of composition changes and do not fully establish their positions until weeks after the effective date. Trading away from the effective date is more prevalent for stocks with lower levels of liquidity and among large index funds, which is consistent with index funds accepting higher tracking error in order to reduce the price impact of their trades. Small and mid-cap funds provide liquidity to index funds around additions, and added stocks with a greater proportion of these natural liquidity providers experience lower inclusion returns.     

S&P 500 trading strategies and stock betas

This paper shows that S&P 500 stock betas are overstatedand the non-S&P 500 stock betas are understated becauseof liquidity price effects caused by the S&P 500 tradingstrategies. The daily and weekly betas of stocks added to theS&P 500 index during 1985-1989 increase, on average, by0.211 and 0.130. The difference between monthly betas of otherwisesimilar S&P 500 and non-S&P 500 stocks also equals 0.125during this period. Some of these increases can be explainedby the reduced nonsynchroneity of S&P 500 stock prices,but the remaining increases are explained by the price pressureor excess volatility caused by the S&P 500 trading strategies.I estimate that the price pressures account for 8.5 percentof the total variance of daily returns of a value-weighted portfolioof NYSE/AMEX stocks. The negative own autocorrelations in S&P500 index returns and the negative cross autocorrelations betweenS&P 500 stock returns provide further evidence consistentwith the price pressure hypothesis.     

Effects of market default risk on index option risk-neutral moments

We investigate the relative importance of market default risk in explaining the time variation of the S&P 500 Index option-implied risk-neutral moments. The results demonstrate that market default risk is positively (negatively) related to the index risk-neutral volatility and skewness (kurtosis). These relations are robust in the presence of other factors relevant to the dynamics and microstructure nature of the spot and option markets. Overall, this study sheds light on a set of economic determinants which help to understand the daily evolution of the S&P 500 Index option-implied risk-neutral distributions. Our findings offer explanations of why theoretical predictions of option pricing models are not consistent with what is observed in practice and provide support that market default risk is important to asset pricing.     

ARE THE STRUCTURAL CHANGES IN MUTUAL FUNDS INVESTING DRIVING THE U.S. STOCK MARKET TO ITS CURRENT LEVELS?

We examine the long-run equilibrium relation between the net flow of funds into equity mutual funds and the S&P 500 index. Applying the Engle and Granger error correction methodology followed by a state space procedure, we find that the levels of the stock market are influenced by the net flow of funds into equity mutual funds. Our findings indicate that the U.S. equity market appears to be rationally adjusting to a structural change in the behavior of the U.S. investing public.     

Inferring volatility dynamics and risk premia from the S&P 500 and VIX markets

We estimate a flexible affine model using an unbalanced panel containing S&P 500 and VIX index returns and option prices and analyze the contribution of VIX options to the model’s in- and out-of-sample performance. We find that they contain valuable information on the risk-neutral conditional distributions of volatility at different time horizons, which is not spanned by the S&P 500 market. This information allows enhanced estimation of the variance risk premium. We gain new insights on the term structure of the variance risk premium, present a trading strategy exploiting these insights, and show how to improve S&P 500 return forecasts.     

Efficiency in index options markets and trading in stock baskets

Researchers have reported mispricing in index options markets. This study further examines the efficiency of the S&P 500 index options market by testing theoretical pricing relationships implied by no-arbitrage conditions. The effect of a traded stock basket, Standard and Poor’s Depository Receipts (SPDRs), on the link between index and options markets is also examined. We find that pricing efficiency within option markets improves but there is little evidence to support the hypothesis that a stock basket enhances arbitrage across markets. When transactions costs and short sales constraints are included, very few violations of inter-market pricing relationships such as put–call parity are reported. However, violations of within market pricing relationships such as the box spread remain frequent. Extensive analysis suggests that the results are robust.     

Recovering the real-world density and liquidity premia from option data

In this paper, we develop a methodology for simultaneous recovery of the real-world probability density and liquidity premia from observed S&P 500 index option prices. Assuming the existence of a numéraire portfolio for the US equity market, fair prices of derivatives under the benchmark approach can be obtained directly under the real-world measure. Under this modelling framework, there exists a direct link between observed call option prices on the index and the real-world density for the underlying index. We use a novel method for the estimation of option-implied volatility surfaces of high quality, which enables the subsequent analysis. We show that the real-world density that we recover is consistent with the observed realized dynamics of the underlying index. This admits the identification of liquidity premia embedded in option price data. We identify and estimate two separate liquidity premia embedded in S&P 500 index options that are consistent with previous findings in the literature.     

Exploiting International Stock Market Correlations with Open-end International Mutual Funds

Investors can exploit the correlations between international stock markets by trading no-load, open-end, international mutual funds. These investors in effect cheat passive investors because they buy the mutual funds at their net asset values, which do not reflect information released during the US trading day. The strategy we examine yields an annual rate of return 800 basis points above the S&P500, over a period of almost eight years.     

An analysis of the importance of S&;P 500 discretionary constituent changes

The main purpose of this paper is to investigate the impact of the S&P 500 index committee’s decisions to change the constituent firms in the index on benchmark risk measures. The index is managed and changed discretionally by the index committee to make it as representative of the market condition as possible. In addition, the index constantly changes due to important corporate events such as bankruptcies, mergers and acquisitions, and spin-offs. We reconstruct market portfolios by retaining all discretionally deleted firms in a 3 and 5 year periods. We estimate betas at every deletion date in terms of reconstructed market portfolios; we found that these estimate betas are significantly different from the betas obtained from the constantly updated S&P 500 portfolio. We also found that such portfolios are less representative of the business cycle than the actual S&P 500 portfolio. Finally, we found that the portfolio returns obtained by retaining all discretionally deleted firms deviate significantly from the returns of the actual S&P 500 index over the studied period, October 1989 to December 2007.     

Efficiency with costly information: a reinterpretation of evidence from managed portfolios

We investigate the informational efficiency of mutual fund performancefor the period 1965-84. Results are shown to be sensitive tothe measurement of performance chosen. We find that returnson S&P stocks, returns on non-S&P stocks, and returnson bonds are significant factors in performance assessment.Once we correct for the impact of non-S&P assets on mutualfund returns, we find that mutual funds do not earn returnsthat justify their information acquisition costs. This is consistentwith results for prior periods.     

The index premium and its hidden cost for index funds

This paper empirically investigates the index premium and its implications from 1990 to 2005. For additions to the S&P 500 and Russell 2000, we find that the price impact from announcement to effective day has averaged + 8.8% and + 4.7%, respectively, and −15.1% and −4.6% for deletions. The premia have been growing over time, peaking in 2000, and declining since then. The implied price elasticity of demand increases with firm size and decreases with idiosyncratic risk, supporting theoretical predictions. We also introduce a new concept that we label the index turnover cost, which represents a hidden cost borne by index funds (and the indexes themselves) due to the index premium. We illustrate this cost and estimate its lower bound as 21-28 bp annually for the S&P 500 and 38-77 bp annually for the Russell 2000.     

Does social network sentiment influence the relationship between the S&P 500 and gold returns?

This study explored the relationship between investor sentiment (extracted from the StockTwits social network), the S&P 500 Index and gold returns. We investigated bilateral causality between gold prices and S&P 500 prices, the power of investor sentiment and gold returns to predict S&P 500 returns, and the influence of gold returns on S&P 500 volatility. We also considered whether the influence of sentiment varies according to the user's degree of experience. We considered the sentiment of messages that mentioned the S&P 500 Index and that users posted between 2012 and 2016. Granger causality analysis, ARIMA models and GARCH models were used for predicting S&P 500 Index returns and S&P 500 volatility. We observed a causal relationship between gold price and the S&P 500 Index. Our results also suggest that sentiment and gold returns predict S&P 500 Index returns. Finally, we observed that gold returns influence S&P 500 volatility and that the sentiment of experienced users affects S&P 500 returns.     

Do economic statistics contain information to predict stock indexes futures prices and returns? Evidence from Asian equity futures markets

This research examines the impact of local and international market factors on the pricing of stock indexes futures in East Asian countries. The purpose of this paper is to present a study of the significant factors that determine the major stock indexes futures’ prices of Hong Kong, Malaysia, Singapore, South Korea and Taiwan. This study first investigates the relationships between Hang Seng Index Futures, KLCI Futures, SiMSCI Futures, KOSPI Futures, Taiwan Exchange Index Futures and local interest rates, dividend yields, local exchange rates, overnight S&P500 index and a newly constructed index, Asian Tigers Malaysia Index (ATMI). 11 years historical data of stock indexes futures and the economic statistics are studied; 10 years in-sample data are used for testing and developing the pricing models, and 1 year out-of-sample data is used for the purpose of verifying the predicted values of the stock indexes futures. Using simple linear regressions, local interest rates, dividend yields, exchange rates, overnight S&P500 and ATMI are found to have significant impact on these futures contracts. In this research, the next period close is predicted using simple linear regression and non-linear artificial neural network (ANN). An examination of the prediction results using nonlinear autoregressive ANN with exogenous inputs (NARX) shows significant abnormal returns above the passive threshold buy and hold market returns and also above the profits of simple linear regression (SLR). The empirical evidence of this research suggests that economic statistics contain information which can be extracted using a hybrid SLR and NARX trading model to predict futures prices with some degree of confidence for a year forward. This justifies further research and development of pricing models using fundamentally significant economic determinants to predict futures prices.