AN EMPIRICAL INVESTIGATION INTO THE IMPACT OF PROFIT SHARING SCHEMES OF EXECUTIVIES ON THE CONTENT OF CORPORATE SUBMISSIONS ON PROPOSED ACCOUNTING STANDARDS

This paper examines the comments submitted by UK companies on 20 proposed accounting standards to test the hypotheses that executives favor standards that increase, or dampen the variance of, accounting profit numbers on which their incentive remuneration is based. Test results were generally as hypothesised but only the profit variance outcomes were statistically significant. Allowing for political environment changes affected only the profit variance results. There was no evidence that the relative monetary size of bonus payments was a significant lobbying factor. No significant differences were found between the lobbying preferences of companies with or without executive incentive schemes.     

Trading frequency and event study test specification

We examine the effects of thin trading on the specification of event study tests. Simulations of upper and lower tail tests are reported with and without variance increases on the event date across levels of trading volume. The traditional standardized test is misspecified for thinly traded samples. If return variance is unlikely to increase, then Corrado's rank test provides the best specification and power. With variance increases, the rank test is misspecified. The Boehmer et al. standardized cross-sectional test (Event-study methodology under conditions of event-induced variance, Journal of Financial Economics 30, pp. 253–272) is properly specified, but not powerful, for upper-tailed tests. Lower-tailed alternative hypotheses can best be evaluated using the generalized sign test.     

Clustering financial time series with variance ratio statistics

This study introduces a new distance measure for clustering financial time series based on variance ratio test statistics. The proposed metric attempts to assess the level of interdependence of time series from the point of view of return predictability. Simulation results show that this metric aggregates time series according to their serial dependence structure better than a metric based on the sample autocorrelations. An empirical application of this approach to international stock market returns is presented. The results suggest that this metric discriminates stock markets reasonably well according to size and the level of development. Furthermore, despite the substantial evolution of individual variance ratio statistics, the clustering pattern remains fairly stable across different time periods.     

A note on the geometry of Shanken's CSR T2 test for mean/variance efficiency

Shanken (1985) derives a test for the zero-beta capital asset pricing model (CAPM) which, as he points out, is equivalent to a test of the mean/variance efficiency of the market portfolio. This note illustrates the geometry of Shanken's test in the mean/variance space.     

UK Housing Market: Time Series Processes with Independent and Identically Distributed Residuals

The paper examines whether a univariate data generating process can be identified which explains the data by having residuals that are independent and identically distributed, as verified by the BDS test. The stationary first differenced natural log quarterly house price index is regressed, initially with a constant variance and then with a conditional variance. The only regression function that produces independent and identically distributed standardised residuals is a mean process based on a pure random walk format with Exponential GARCH in mean for the conditional variance. There is an indication of an asymmetric volatility feedback effect but higher frequency data is required to confirm this. There could be scope for forecasting the index but this is tempered by the reduction in the power of the BDS test if there is a non-linear conditional variance process.     

Discriminating between wealth and information effects in event studies in accounting and finance research

This article examines the power of tests of given size to detect and distinguish between wealth (i.e., mean) and information (i.e., variance) effects in event studies. We find that an Estimated Generalized Least Squares (EGLS) mean-effects test is consistently more powerful than the test based upon the average standardized residual and is as powerful as a nonparametric rank test. Unlike the test based upon the average standardized residual and the rank test, the EGLS test is well specified even when the event affects the variances of the prediction errors. We also find that conventional parametric tests to detect changes in the variance of the event-day average abnormal return are misspecified when the null of no change is true. We analyze the reasons this occurs and suggest a rank procedure that produces tests of the correct size under the null. Our evidence suggests that the critical factors allowing researchers to distinguish between wealth and information effects are an estimation procedure incorporating the heteroskedasticity inherent in market model prediction errors and an explicit test for event-day variance changes.     

Mean and Variance Causality between Official and Parallel Currency Markets: Evidence from Four Latin American Countries

This paper examines the issue of mean and variance causality across four Latin American official and black markets for foreign currency using monthly data for the period 1976–1993. We apply a recent test developed by Cheung and Ng (1996) in order to test for mean and variance spillovers. The main findings are: (1) In contrast to the findings of previous studies, EGARCH-M processes characterize each bilateral exchange rate series in both markets; (2) There is substantial evidence of causality in both mean and variance with the causality in mean largely being driven by the causality in variance; and (3) The results indicate that the major exporter of causality is the Mexican black market with the black market of Argentina and the black and official markets of Brazil being the smallest contributors.     

Testing for Volatility Jumps in the Stochastic Volatility Process

This paper considers the stochastic volatility process with contemporaneous and correlated jumps in returns and volatility, which was proposed by Eraker, B., Johannes, M. and Poison, N. G. (Journal of Finance 53, 2003, 1269--1300) and proposes the Lagrange multiplier test for the presence of jumps in volatility. The test statistic is derived by regarding the degenerate density of volatility jumps with zero variance under the null as Dirac's delta function. The correlation parameter between jumps, which is a nuisance parameter unidentified under the null, is cancelled out in this test statistic and hence the test is free from the Davies problem (Davies, R. B., Biometrika 64, 1977, 247–254).     

A minimum variance benchmark to measure the performance of pension funds in Mexico

We propose the use of the minimum variance portfolio as weighting method in a strategy benchmark for pension funds performance in Mexico. By performing three discrete event simulations with daily data from January 2002 to May 2013, we test this benchmark's weighting method against the Max Sharpe ratio one and a linear combination of both benchmarks (minimum variance and Max Sharpe). With the Sharpe ratio, the Jensen's alpha significance test and the Huberman and Kandel’ (1987) spanning test, we found that the three benchmarks have a statistically equal performance. By using Bailey's (1992) risk exposure, market representativeness and turnover benchmark quality criteria, we found that the min variance is preferable for the publicly traded Mexican defined contribution pension funds.     

Liquidity,implied volatility and tail risk: A comparison of liquidity measures

Liquidity is easily perceived but not easily measured in financial markets. Researchers and practitioners develop and test new measures of liquidity which may be good candidates for measuring this elusive concept. In this study, we present a comparison of variables within two empirical exercises using up to eight traditional liquidity proxies and two proposed proxies based on semi-deviations in a sample of NYSE-listed stocks. The first empirical exercise analyzes the relationship between liquidity and implied volatility, showing that increases in implied volatility impacts increases illiquidity. Using a decomposition of the squared VIX, we show that both conditional variance and variance premium components affects liquidity. Our second empirical exercise investigates the relationship between common factors in liquidity and tail risk. Common factors increase individual stocks' Value-at-Risk and Expected Shortfall, although the effect is not significant for market risk. In both applications, most of the studied proxies present results aligned with the body of literature.     

Automatic variance ratio test under conditional heteroskedasticity

An extensive Monte Carlo experiment is conducted to evaluate small sample properties of the automatic variance ratio test under conditional heteroskedasticity. It is found that the test shows serious size distortion in small samples. For improved small sample performance, this paper proposes the use of wild bootstrap. When wild bootstrapped, the automatic variance ratio test shows no size distortion, and it has power substantially higher than its competitors such as the Chen–Deo test and wild bootstrap Chow–Denning test.     

On market efficiency of Asian foreign exchange rates: evidence from a joint variance ratio test and technical trading rules

This study employs a joint variance ratio test and technical trading rules to examine the random walk behavior for nine Asian foreign exchange rates for the period 1988–1995. The joint variance ratio test results suggest that there is little evidence of serial correlations in the daily exchange rate series. The results also indicate that, in general, the moving average and channel trading rules do not generate significant, positive profits.     

Within and between-country variances in inflation rates : Are they similar?

This paper critiques the test which led Hans Genberg to the widely cited finding that the variance in inflation rates across OECD countries under fixed exchange rates was not significantly different from the variance in inflation rates across U.S. cities. It offers a more appropriate test which indicates that, in fact, there is a highly significant difference in the variance of inflation rates within and among countries.     

Options on realized variance by transform methods: a non-affine stochastic volatility model

In this paper we study the pricing and hedging of options on realized variance in the 3/2 non-affine stochastic volatility model by developing efficient transform-based pricing methods. This non-affine model gives prices of options on realized variance that allow upward-sloping implied volatility of variance smiles. Heston's model [Rev. Financial Stud., 1993, 6, 327–343], the benchmark affine stochastic volatility model, leads to downward-sloping volatility of variance smiles—in disagreement with variance markets in practice. Using control variates, we propose a robust method to express the Laplace transform of the variance call function in terms of the Laplace transform of the realized variance. The proposed method works in any model where the Laplace transform of realized variance is available in closed form. Additionally, we apply a new numerical Laplace inversion algorithm that gives fast and accurate prices for options on realized variance, simultaneously at a sequence of variance strikes. The method is also used to derive hedge ratios for options on variance with respect to variance swaps.     

Optimal asset allocation using a combination of implied and historical information

This paper investigates the contribution of option-implied information for strategic asset allocation for individuals with minimum-variance preferences and portfolios with a variety of assets. We propose a covariance matrix that exploits a mixture of historical and option-implied information. Implied variance measures are proposed for those assets for which option-implied information is available. Historical variance and correlation measures are applied to the remaining assets. The performance of this novel approach for constructing optimal investment portfolios is assessed out-of-sample using statistical and economic measures. An empirical application to a sophisticated portfolio comprised by a combination of equities, fixed income, alternative securities and cash deposits shows that implied variance measures with risk premium correction outperform variance measures constructed from historical data and implied variance without correction. This result is robust across investment portfolios, volatility and portfolio performance metrics, and rebalancing schemes.     

VARIANCE BOUND TESTS OF BOND MARKET EFFICIENCY

In this paper we examine variance bound tests of the joint hypothesis that (1) bond markets are efficient and (2) the term structure is determined by the expectations hypothesis. Both the Singleton and Shiller tests are shown to be seriously biased toward rejecting the joint hypothesis in finite samples. Flavin's test is unbiased but has a very high variance leading to many false rejections of the joint hypothesis. When corrected as suggested by Flavin, Shiller's test is unbiased and has a relatively low variance. Unfortunately, it is also sensitive to measurement error.     

Estimating and Testing Exponential-Affine Term Structure Models by Kalman Filter

This paper proposes a unified state-space formulation for parameter estimation of exponential-affine term structure models. The proposed method uses an approximate linear Kalman filter which only requires specifying the conditional mean and variance of the system in an approximate sense. The method allows for measurement errors in the observed yields to maturity, and can simultaneously deal with many yields on bonds with different maturities. An empirical analysis of two special cases of this general class of model is carried out: the Gaussian case (Vasicek 1977) and the non-Gaussian case (Cox Ingersoll and Ross 1985 and Chen and Scott 1992). Our test results indicate a strong rejection of these two cases. A Monte Carlo study indicates that the procedure is reliable for moderate sample sizes.     

Dependence and mean reversion in stock prices: The case of the MENA region

This paper provides empirical evidence on the long memory behavior of the stock markets of Egypt, Jordan, Morocco, and Turkey. To test for long memory in the returns and volatility, we employ the modified rescaled range statistic R/S proposed by Lo [Lo, A.W., 1991. Long-term memory in stock market prices. Econometrica 59, 1279–1313] and the recently proposed rescaled variance V/S statistic developed by Giraitis et al. [Giraitis, L., Kokoszka, P.S. Leipus, R., Teyssiere, G., 2003. Rescaled variance and related tests for long memory in volatility and levels. J. Econ. 112, 265–294]. Further analysis is conducted by employing the ARFIMA (p, d, q) model to estimate the long memory parameters. Egypt and Morocco show evidence of long memory in the return series, while Jordan and Turkey display negative persistence. For the volatility series, long memory is conclusively demonstrated for all markets. Then, we compare the forecasting performance of ARMA and ARFIMA models and find that the ARFIMA model outperforms in out-of-sample forecasting of the markets. Our results should be useful to regulators, practitioners and derivative market participants, whose success depends on the ability to forecast stock price movements in these markets.     

Analysis of variance based instruments for Ornstein–Uhlenbeck type models: swap and price index

In this paper a couple of variance dependent instruments in the financial market are studied. Firstly, a number of aspects of the variance swap in connection to the Barndorff-Nielsen and Shephard model are studied. A partial integro-differential equation that describes the dynamics of the arbitrage-free price of the variance swap is formulated. Under appropriate assumptions for the first four cumulants of the driving subordinator, a Ve?e?-type theorem is proved. The bounds of the arbitrage-free variance swap price are also found. Finally, a price-weighted index modulated by market variance is introduced. The large-basket limit dynamics of the price index and the “error term” are derived. Empirical data driven numerical examples are provided in support of the proposed price index.