Risk premia in forward exchange rates: systematic or unsystematic?

International traders frequently use forward exchange transactions to hedge their cash flows in foreign currencies. A key issue is whether the forward rates are efficiently priced. There is evidence of time-varying risk premia in forward exchange rates. Are these risk premia systematic or unsystematic? This article uses a market model to explain risk, implying that the risk premium in the forward rate varies pari passu with the beta of the return to speculative forward positions. Assuming the unobserved risk premium is proportional to the forward premium allows testing the predicted relations; the data reject the joint hypotheses of the model and systematic risk. In terms of a simple factor model explaining the covariation of the forward premium, the risk premium, and the expected percentage rate of change of the spot exchange rate, the assumption that the forward premium and the risk premium are proportional can be relaxed without changing the empirical results.     

Intradaily periodicity and volatility spillovers between international stock index futures markets

This paper examines short‐run information transmission between the U.S. and U.K. markets using the S&P 500 and FTSE 100 index futures. Ultrahighfrequency futures data are employed—which have a number of advantages over the low‐frequency spot data commonly used in previous studies—in establishing that volatility spillovers are in fact bidirectional. The generalized autoregressive conditionally heteroskedastic model (GARCH) is employed to estimate the mean and volatility spillovers of intraday returns. A Fourier flexible function is utilized to filter the intradaily periodic patterns that induce serial correlation in return volatility. It was found that estimates of volatility persistence and speed of information transmission are seriously affected by intradaily periodicity. The bias in parameter estimation is removed by filtering out the intradaily periodic component of the transaction data. Contrary to previous findings, there is evidence of spillovers in volatility between the U.S. and U.K. markets. Results indicate that the volatility of the U.S. market is affected by the most recent volatility surprise in the U.K. market. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:553–585, 2005     

The effect of net positions by type of trader on volatility in foreign currency futures markets

We investigate the effect of net positions by type of trader on return volatility in six foreign currency futures markets using the weekly Commitments of Traders (COT) data. When net positions are decomposed into expected and unexpected components, we find that expected net positions by type of trader generally do not co‐vary with volatility. However, volatility is positively associated with shocks (in either direction) in net positions of speculators and small traders, and negatively related to shocks (in either direction) in net positions of hedgers. This evidence suggests that changes in speculative positions destabilize the market. Consistent with dispersion of beliefs models and noise trading theories, hedgers appear to possess private information, whereas speculators and small traders are less informed in these markets. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:427–450, 2002     

Naming Products in China: Local or Foreign Branding

ABSTRACT

This study examines the effect of program trades on the price changes in the Korean stock index futures and spot markets employing intraday return and trading data. Program trades in the Korean stock market create an instant imbalance in market liquidity. However, their impact is very short-lived and limited in an economic sense. Moreover, there is little tendency for market returns to over-react to program trades. An increase in program trades results in higher spot market volatility but does not cause monotonically increasing futures market volatility. Overall, program trades do not destabilize the stock market in Korea despite some positive association between program trades and volatility.     

The temporal relationship between derivatives trading and spot market volatility in the U.K.: Empirical analysis and Monte Carlo evidence

This article examines empirically the dynamic relationship between spot market volatility, futures trading, and options trading in the context of a trivariate simultaneous equations model. The empirical analysis provides strong evidence that significant simultaneity, in addition to feedback, characterizes the relationship between the proxy for time-varying spot market volatility and derivative trading. Also, futures trading and options trading are found to affect spot market volatility in opposite directions in the structural model proposed. The results, corroborated by Monte Carlo evidence, suggest that the failure to account for any contemporaneous interaction between the variables under consideration, as well as the omission of any of the two derivatives trading activities examined in this study, may generate serious misspecification and ultimately produce misleading estimation results and statistical inference. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 245–270, 1999     

Call Warrant Listing and the Behavior of its Underlying Spot Market: Some Evidence from Bursa Malaysia

This study investigates the call warrant listing impact on its underlying stock based on Malaysian stock market. The study indicates that call warrant listing has no significant impact on the return, volatility, and bid-ask spread of its underlying stock. However, its trading volume tends to be higher in the post event period. The results suggest that (1) the diversion of trade from spot to warrant market is nonexistent, (2) call warrant does not expand the opportunity set for investors, (3) it is fair to use historical data in volatility estimation for the purpose of asset pricing based on Malaysian context.     

The effect of spot and futures trading on stock index market volatility: A nonparametric approach

This article provides empirical evidence on the intraday relation between spot volatility and trading volume in the Spanish stock index futures market. GARCH methodology is used to estimate spot volatility. We analyze the potential relation between spot and futures trading volume and spot volatility by estimating the corresponding conditional density functions as proposed in Quah (1997). Our results reveal no significant link between those variables. Similar findings arise when expected and unexpected volume is considered. Our results suggest that derivative market is not a force behind episodes of significant spot jump volatility. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:841–858, 2003     

Volatility spillover and hedging effectiveness among China and emerging Asian Islamic equity indexes

We study the volatility spillover between China and Asian Islamic stock markets. We use a sample of six Islamic MSCI indices from the Asian region, namely China, India, Malaysia, Indonesia, Korea and Thailand obtained from MSCI (Morgan Stanley Capital International). In this paper we analyze the importance of considering spillover effects between emerging Asian Islamic indexes based on the Bivariate VARMA-BEKK-AGARCH model of McAleer et al. (2009), which includes spillover and asymmetric effects. We compute after the effectiveness of portfolio diversification based on the conditional volatility of returns series. Results show a significant positive and negative return spillover from China to selected Asian Islamic stock market and bidirectional volatility spillovers between China, Korea and Thailand Islamic market showing evidence of short-term predictability on Islamic Chinese stock market movements. However there is no short term volatility persistence in India, Indonesia and Malaysia. GARCH results show no persistence in volatility spillover effect in long term from Chinese to Indian, Indonesian and Korean Islamic stock market. Our findings are beneficial for international portfolio diversification for policy makers and investors since the results of portfolio management and hedging effectiveness ratio are different to previous studies.     

Intraday Volatility in Interest‐Rate and Foreign‐Exchange Markets: ARCH,Announcement, and Seasonality Effects

We explore the determinants of intraday volatility in interest‐rate and foreign‐exchange markets, focusing on the importance and interaction of three types of information in predicting intraday volatility: (a) knowledge of recent past volatilities (i.e., ARCH or Autoregressive Conditional Heteroskedasticity effects); (b) prior knowledge of when major scheduled macroeconomic announcements, such as the employment report or Producer Price Index, will be released; and (c) knowledge of seasonality patterns. We find that all three information sets have significant incremental predictive power, but macroeconomic announcements are the most important determinants of periods of very high intraday volatility (particularly in the interest‐rate markets). We show that because the three information sets are not independent, it is necessary to simultaneously consider all three to accurately measure intraday volatility patterns. For instance, we find that most of the previously documented time‐of‐day and day‐of‐the‐week volatility patterns in these markets are due to the tendency for macroeconomic announcements to occur on particular days and at particular times. Indeed, the familiar U‐shape completely disappears in the foreign‐exchange market. We also find that estimates of ARCH effects are considerably altered when we account for announcement effects and return periodicity; specifically, estimates of volatility persistence are sharply reduced. Separately, our results show that high volatility persists longer after shocks due to unscheduled announcements than after equivalent shocks due to scheduled announcements, indicating that market participants digest information much more quickly if they are prepared to receive it. However, contrary to results from equity markets, we find no evidence of a meaningful difference in volatility persistence after positive or negative price shocks. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21: 517–552, 2001     

Risk and ex ante cost of equity estimates of emerging market firms

We examine the empirical relationship between estimates of ex ante cost of equity and risk for a sample of individual emerging market equities for the period 1990–2000. The ex ante cost of equity estimates are obtained using the residual income valuation model. As in studies that use mean realized returns on emerging market indexes, a measure of total risk (return volatility) is the most significant risk factor in explaining ex ante expected return estimates. For emerging market equities with substantial investability to global investors, global beta adds some explanatory power.     

Turnover and return in global stock markets

I study how growth affects liquidity of global stock exchanges and how liquidity determines cross-sectional returns on those stock exchange index portfolios. I measure portfolio liquidity by turnover ratio computed as value of shares traded over the market capitalization. I obtain data from FIBV, an association of global stock exchanges. In a multiple regression model for turnover ratio, I find age, size, type of exchange, competition for order flow, and growth rate to be significant determinants of portfolio liquidity; however, exchange- and time-specific effects are more appropriate for modeling portfolio liquidity. The time effects yield to three distinct regimes, while the exchange-specific effects are surrogates for the legal systems, English common law, and Civil laws of the countries. I estimate the parameters of a multiple regression model in a two-stage GLS framework in which index return is a function of turnover. The GLS method is preferable since a turnover ratio may have a non-stationary, random component. The significant determinants of index return are turnover and volatility, although some of the volatility effect may be a spillover from a January effect. Investors expect higher return from high turnover markets. However, the positive turnover expected return relation is true only in emerging markets; in developed markets expected return is a function of volatility. This result confirms existing empirical evidence that high turnover stock portfolios generate superior returns and further the sources and pricing of risk in emerging and developed markets are different.     

我国期货市场的波动性与有效性--基于三大交易市场的实证分析

通过对中国三大期货市场的铜、黄豆和小麦三种主要期货品种收益率的分布与波动性的实证分析 ,论证了其时间序列存在ARCH效应 ;运用GARCH模型对这三种期货品种进行了拟合分析和统计检验 ,检验结果表明这三个期货品种的波动性均具有很高的持续性 ,但大连黄豆的波动持续性弱于上海铜和郑州小麦 ,其波动性受各种外部冲击的影响较大 ;通过GARCH( 1 ,1 )的市场有效性检验 ,论证了中国期货市场尚未达到弱式有效 ,市场风险较大。     

The impact of volatility derivatives on S&P500 volatility

This study investigates whether the newly cultivated platform of volatility derivatives has altered the volatility of the underlying S&P500 index. The findings suggest that the onset of the volatility derivatives trading has lowered the volatility of both the cash market volatility and the cash market index, and significantly reduced the impact of shocks to volatility. When big sudden events hit financial markets, however, the volatility of volatility seems to elevate in the U.S. equity market as a result of increased global correlations. Regardless of the period under examination and the estimator employed, long‐run volatility persistence is present. The latter drops significantly when the credit crunch period is excluded from the post‐event date sample period. The correlation between the broad equity index and the return volatility remains low, which in turn strengthens the role of volatility derivatives to facilitate portfolio diversification. The analysis also shows that volatility is mean reverting, whereas market data support the impact of information asymmetries on conditional volatility. In the post‐event date phase, no asymmetries are found when the recent crisis is not accounted for. Finally, comparisons with other international equity indices, with no volatility derivatives listed, unveil that these indices exhibit higher volatility and slower recovery from shocks than the S&P500 index. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:1190–1213, 2009     

Dividend‐Rollover Effect and the Ad Hoc Black‐Scholes Model

One of the most widely used option‐valuation models among practitioners is the ad hoc Black‐Scholes (AHBS) model. The main contribution of this study is methodological. We carefully consider three dividend strategies (No dividend, Implied‐forward dividend, and Actual dividend) for the AHBS model to investigate their effect on pricing errors. We suggest a new dividend strategy, implied‐forward dividend, which incorporates expectational information on dividends embedded in option prices. We demonstrate that our implied‐forward dividend strategy produces more consistent estimates between in‐sample market and model option prices. More importantly our new implied‐forward dividend strategy makes more accurate out‐of‐sample forecasts for one‐day or one‐week ahead prices. Second, we document that both a “Return‐volatility” Smile and a “Return‐pricing Error” Smile exist. From these return characteristics, we make two conclusions: (1) the return dependency of implied volatility is an important explanatory variable and should be controlled to reduce the pricing error of an AHBS model, and (2) it is important for the hedging horizon to be based on return size, that is, the larger the contemporaneous return, the more frequent an option issuer must rebalance the option's hedge. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 32:742‐772, 2012     

Emerging Equity Market Volatility

Abstract

This paper considers two emerging markets that are under-researched, Kenya and Nigeria. It offers a comprehensive view of four time properties that emerged from the empirical time series literature on asset returns: (1) the predictability of returns from past observations; (2) the auto-regressive behavior of conditional volatility; (3) the asymmetric response of conditional volatility to innovations; and (4) the conditional variance risk premium. Results of the exponential GARCH (EGARCH) model indicate that asymmetric volatility found in the U.S. and other developed markets also characterized the Nigerian stock exchange. In Kenya, however, the asymmetric volatility coefficient is significant and positive, suggesting that positive shocks increase volatility more than negative shocks of an equal magnitude. The Nairobi Stock Exchange (KSE) returns series report negative but insignificant risk-premium parameters. In Nigeria (NSE), return series exhibit a significant and positive time-varying risk premium. The results also show that expected returns are predictable, that the auto-regressive return parameters (? ₁ ) are significant in both Kenya and Nigeria. Finally, the GARCH parameter (b) is statistically significant, indicating that volatility persistence is present in the two emerging markets studied.     

Does Index Futures Trading Reduce Volatility in the Chinese Stock Market? A Panel Data Evaluation Approach

This study investigates the effect of introducing index futures trading on the spot price volatility in the Chinese stock market. We employ a recently developed panel data policy evaluation approach (Hsiao, Ching, and Wan, 2011) to construct counterfactuals of the spot market volatility, based mainly on cross‐sectional correlations between the Chinese and international stock markets. This new method does not need to specify a particular regression or a time‐series model for the volatility process around the introduction date of index futures trading, and thus avoids the potential omitted variable bias caused by uncontrolled market factors in the existing literature. Our results provide empirical evidence that the introduction of index futures trading significantly reduces the volatility of the Chinese stock market, which is robust to different model selection criteria and various prediction approaches. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:1167–1190, 2013     

THE STOCHASTIC VOLATILITY MODEL OF BARNDORFF‐NIELSEN AND SHEPHARD IN COMMODITY MARKETS

We consider the non‐Gaussian stochastic volatility model of Barndorff‐Nielsen and Shephard for the exponential mean‐reversion model of Schwartz proposed for commodity spot prices. We analyze the properties of the stochastic dynamics, and show in particular that the log‐spot prices possess a stationary distribution defined as a normal variance‐mixture model. Furthermore, the stochastic volatility model allows for explicit forward prices, which may produce a hump structure inherited from the mean‐reversion of the stochastic volatility. Although the spot price dynamics has continuous paths, the forward prices will have a jump dynamics, where jumps occur according to changes in the volatility process. We compare with the popular Heston stochastic volatility dynamics, and show that the Barndorff‐Nielsen and Shephard model provides a more flexible framework in describing commodity spot prices. An empirical example on UK spot data is included.     

Pricing Eurodollar Futures Options with the Heath—Jarrow—Morton Model

This article uses the algorithm developed by Ritchken and Sankarasubramanian (1995) to make comparisons among the Heath—Jarrow—Morton (HJM) models (Heath, Jarrow, & Morton, 1992) with different volatility structures in pricing the Eurodollar futures options. We show that the differences among the HJM models as well as the difference between the HJM models and Black's model can be insignificant when the volatility of the forward rate is relatively small. Moreover, our findings imply that the difference between the American‐style and European‐style options is insignificant for options with a life of less than 1 year. However, the difference can be significant for options with a 1‐year maturity, the difference depending on the exercise price. Finally, our tests indicate that the difference between the forward price and the futures price is insignificant if the volatility parameter is low enough and when the volatility of the spot rate is proportional to the spot rate. A higher volatility parameter can lead to a significant difference between the forward price and the futures price, although its impact on the price of the options will still be trivial. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21: 655–680, 2001     

Existence of a calibrated regime switching local volatility model

By Gyöngy's theorem, a local and stochastic volatility model is calibrated to the market prices of all European call options with positive maturities and strikes if its local volatility (LV) function is equal to the ratio of the Dupire LV function over the root conditional mean square of the stochastic volatility factor given the spot value. This leads to a stochastic differential equation (SDE) nonlinear in the sense of McKean. Particle methods based on a kernel approximation of the conditional expectation, as presented in Guyon and Henry‐Labordère [Risk Magazine, 25, 92–97], provide an efficient calibration procedure even if some calibration errors may appear when the range of the stochastic volatility factor is very large. But so far, no global existence result is available for the SDE nonlinear in the sense of McKean. When the stochastic volatility factor is a jump process taking finitely many values and with jump intensities depending on the spot level, we prove existence of a solution to the associated Fokker–Planck equation under the condition that the range of the squared stochastic volatility factor is not too large. We then deduce existence to the calibrated model by extending the results in Figalli [Journal of Functional Analysis, 254(1), 109–153].     

Natural Selection and Market Efficiency in a Futures Market with Random Shocks

Even when participants know very little about their environment, the market itself, by serving as a selection process of information, promotes an efficient aggregate outcome. To emphasize the role of the market and the importance of natural selection rather than the strategic actions of participants, an evolutionary model of a commodity futures market is presented, in which there is a continual inflow of unsophisticated traders with predetermined distributions of prediction errors with respect to the fundamental value of the spot price. The market acts as a selection process by constantly shifting wealth from traders with less accurate information to those with more accurate information. Consequently, with probability 1, if the volatility of the underlying spot market is sufficiently small, the proportion of time that the futures price is sufficiently close to the fundamental value converges to one. Furthermore, the width of the interval containing the fundamental value, where the futures price eventually lies, increases as the volatility of the underlying spot market increases. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:489–516, 2001