Accounting for decarbonisation and reducing capital at risk in the S&P500

This article accounts for carbon emissions in the S&P 500 and explores the extent to which capital is at risk from decarbonising value chains. At a global level it is proving difficult to decouple carbon emissions from GDP growth. Top-down legal and regulatory arrangements envisaged by the Kyoto Protocol are practically redundant given inconsistent political commitment to mitigating global climate change and promoting sustainability. The United Nations Environment Programme (UNEP) and European Commission (EC) are promoting the role of financial markets and financial institutions as drivers of behavioural change mobilising capital allocations to decarbonise corporate activity.     

A re-examination of the index effect: Gambling on additions to and deletions from the S&P 500's ‘gold seal’

This study examines the abnormal returns, trading activity, volatility and long-term performance of stocks that were added to the S&P 500 index. By using a three-factor pricing model that allows for firm size and value characteristics as well as market risk, we are able to shed new light on the widely observed ‘index effect’. We find that the CAPM tends to overstate the performance of large firms and to understate the performance of small firms. We also find a transitory increase in trading volume between the announcement and a few days after the effective date. In terms of the firm's operating performance, we find a significant increase in earnings per share after inclusion, which combines with the stock price rise to leave the average price-earnings ratio largely unaltered. Examining a unique sample of deletions of international companies and replacements with US companies, we find that deleted stocks experienced a considerable and permanent fall in price, inconsistent with the Investor Recognition Hypothesis. The “seal” of S&P 500 index membership has very long-term effects and inclusion appears not to be an information-free event.     

Option pricing under stock market cycles with jump risks: evidence from the S&P 500 index

Review of Quantitative Finance and Accounting - This study incorporates the Markov switching model with return jumps to depict the behavior of stock returns. Based on the daily Standard &...     

The Effect of Option Trading on the Structure of Equity Bid/Ask Spreads

This paper investigates empirically the direct effect of option trading on the structure of costs that comprise the underlying equity bid-ask spread. Our results show that the spread declines over a 30-day period following initiation of option trading, but the decline vanishes when price, volume, and volatility effects are considered. Changes in the composition of the spread reflect primarily a reduction in adverse information costs. Additionally, consistent with previous research, we find significant transaction-type clustering in our intraday data.     

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.     

The Split of the S&P 500 Futures Contract: Effects on Liquidity and Market Dynamics

The Chicago Mercantile Exchange reduced the size of its S&P 500 futures contract when it reduced the multiplier from 500 to 250 and increased the minimum tick from 0.05 to 0.10 on November 3, 1997. This is a rare major change in a very successful contract's specifications. We analyze effects of this change on liquidity and market dynamics in both a univariate and a multivariate context. The main contribution of this study is the use of multiple intervention analysis with various dynamic response functions to examine the effects of the split while taking into account several other major market events surrounding it. A multivariate analysis is also used to test the impact of the split using a structural model of liquidity and market dynamics. Empirical findings offer limited support for the hypotheses that smaller contract size resulted in smoother trading, and that more public customers trade the S&P 500 futures contract following its split. We observe a reduction in the average transaction size as well as a temporary narrowing of the bid-ask spreads, but no significant change in volatility that can be attributed to the split. We do not find any significant and lasting impact on other liquidity and market variables.     

The jump component of S&P 500 volatility and the VIX index

Much research has investigated the differences between option implied volatilities and econometric model-based forecasts. Implied volatility is a market determined forecast, in contrast to model-based forecasts that employ some degree of smoothing of past volatility to generate forecasts. Implied volatility has the potential to reflect information that a model-based forecast could not. This paper considers two issues relating to the informational content of the S&P 500 VIX implied volatility index. First, whether it subsumes information on how historical jump activity contributed to the price volatility, followed by whether the VIX reflects any incremental information pertaining to future jump activity relative to model-based forecasts. It is found that the VIX index both subsumes information relating to past jump contributions to total volatility and reflects incremental information pertaining to future jump activity. This issue has not been examined previously and expands our understanding of how option markets form their volatility forecasts.     

The smirk in the S&P500 futures options prices: a linearized factor analysis

In the S&P500 futures options, we identify three factors, corresponding to movements in the underlying, parallel movements, and tilting of the cross section of implied volatilities (the “smirk factor”). We relate these factors non-linearly to movements in the option prices. They seem to be diffusive in nature, have significant associated risk premia, and can account for an overwhelming part of the option price movements. We interpret the options smirk, which is the notion that out-of-the-money (OTM) puts seem expensive relative to OTM calls, in terms of the prices of these risk factors. Going short OTM puts and long OTM calls, corresponding to the third factor, makes a profit on average, but this corresponds to its risk premium, and does not represent a market inefficiency. Our smirk factor is useful for hedging option portfolios, but seems unrelated to movements in the underlying, and does not fit into the framework of the jump-diffusion models.      

The innovations of e-mini contracts and futures price volatility components: The empirical investigation of S&P 500 stock index futures

The effect of the initiation of e-mini stock index futures (ESIFs) on the volatility components of S&P 500 stock index futures is herein investigated. The study decomposes S&P 500 stock index-related observed volatilities into unobserved fundamental volatility and transitory noise and utilizes the decomposition to test two hypotheses: the “clientele factor hypothesis” and the “information adjustment hypothesis”. The first hypothesis proposes that the ESIFs attract more noisy traders who prefer trading the friendly-size futures contracts. The second one proposes that the innovations of ESIFs improve the information flow of the futures markets. Using a stochastic volatility model, the empirical results are consistent with both of our proposed hypotheses.     

Volatility dynamics for the S&P 500: Further evidence from non-affine,multi-factor jump diffusions

We apply Markov chain Monte Carlo methods to time series data on S&P 500 index returns, and to its option prices via a term structure of VIX indices, to estimate 18 different affine and non-affine stochastic volatility models with one or two variance factors, and where jumps are allowed in both the price and the instantaneous volatility. The in-sample fit to the VIX term structure shows that the second (stochastic long-term volatility) factor is required to fit the VIX term structure. Out-of-sample tests on the fit to individual option prices, as well as in-sample tests, show that the inclusion of jumps is less important than allowing for non-affine dynamics. The estimation and testing periods together cover more than 21 years of daily data.     

The relationship between implied and realized volatility: evidence from the Australian stock index option market

This paper examines the relationship between the volatility implied in option prices and the subsequently realized volatility by using the S&P/ASX 200 index options (XJO) traded on the Australian Stock Exchange (ASX) during a period of 5 years. Unlike stock index options such as the S&P 100 index options in the US market, the S&P/ASX 200 index options are traded infrequently and in low volumes, and have a long maturity cycle. Thus an errors-in-variables problem for measurement of implied volatility is more likely to exist. After accounting for this problem by instrumental variable method, it is found that both call and put implied volatilities are superior to historical volatility in forecasting future realized volatility. Moreover, implied call volatility is nearly an unbiased forecast of future volatility.

Macroeconomic variables and the E/P ratio: Is inflation really positively associated with the E/P ratio?

We examine the economywide E/P ratio both over a long time period (1952–2003) and by dividing the entire period into subperiods. We have two main objectives. First, we reexamine the puzzling result documented by Modigliani and Cohn (1979), who find that, contrary to theory, the economy wide E/P ratio and inflation are positively correlated. Our longer period of analysis allows us to divide the entire period into subperiods with differing macroeconomic environments. We find that the Modigliani and Cohn anomaly is period specific. The association between the E/P ratio and inflation reverses from one period to another. Hence, the relation between inflation and the economywide E/P ratio is not stable over a long time period. Second, we analyze the associations between the economywide E/P ratio and its two main drivers as given by the Gordon (1962) model. We find that the economywide E/P ratio (a) is not associated with the real interest rate and (b) is weakly negatively associated with the expected growth rate. Findings for inflation do not change when we include or exclude other E/P drivers in regression specifications.     

The Price Response to S&P 500 Index Additions and Deletions: Evidence of Asymmetry and a New Explanation

We study the price effects of changes to the S&P 500 index and document an asymmetric price response: There is a permanent increase in the price of added firms but no permanent decline for deleted firms. These results are at odds with extant explanations of the effects of index changes that imply a symmetric price response to additions and deletions. A possible explanation for asymmetric price effects arises from the changes in investor awareness. Results from our empirical tests support the thesis that changes in investor awareness contribute to the asymmetric price effects of S&P 500 index additions and deletions.     

The effects of changes in index composition on stock prices and volume: Evidence from the Istanbul stock exchange

Previous evidence has shown that stocks included in (excluded from) an index exhibit significant positive (negative) abnormal returns on the announcement day, and that trading volume is affected by the event. This study examines the price and volume effects on stocks associated with the changes in the value-weighted index composition of two indices, of the ISE, where the index funds and index derivatives do not exist. Consistent with previous evidence, stocks included in (excluded from) the index tend to generate positive (negative) abnormal returns in ISE. Volume and volume volatility are also significantly affected. Our results seem to support the hypotheses of price-pressure, imperfect substitute and attention due to the lack of index-funds and derivatives market in Turkey.     

The tick/volatility ratio as a determinant of the compass rose: empirical evidence from decimalisation on the NYSE

Recent research suggests that volatility has an important role to play in the appearance of the compass rose pattern. The introduction of decimal prices on the New York Stock Exchange (NYSE) provides an ideal opportunity to test this hypothesis using actual market data. The empirical evidence presented in this paper suggests that the 85 per cent reduction in the tick/volatility ratio resulting from the decimalisation of prices was not sufficient to eliminate the compass rose pattern.