Basket trading under co-integration with the logistic mixture autoregressive model

In this paper, we propose a co-integration model with a logistic mixture auto-regressive equilibrium error (co-integrated LMAR), in which the equilibrium relationship among cumulative returns of different financial assets is modelled by a logistic mixture autoregressive time series model. The traditional autoregression (AR) based unit root test (ADF test), used in testing co-integration, cannot give a sound explanation when a time series passes the ADF test. However, its largest root in the AR polynomial is extremely close to, but less than, one, which is most likely the result of a mixture of random-walk and mean-reverting processes in the time series data. With this background, we put an LMAR model into the co-integration framework to identify baskets that have a large spread but are still well co-integrated. A sufficient condition for the stationarity of the LMAR model is given and proved using a Markovian approach. A two-step estimating procedure, combining least-squares estimation and the Expectation-Maximization (EM) algorithm, is given. The Bayesian information criterion (BIC) is used in model selection. The co-integrated LMAR model is applied to basket trading, which is a widely used tool for arbitrage. We use simulation to assess the model in basket trading strategies with the statistical arbitrage feature in equity markets. Data from several sectors of the Hong Kong Hang Seng Index are used in a simulation study on basket trading. Empirical results show that a portfolio using the co-integrated LMAR model has a higher return than portfolios selected by traditional methods. Although the volatility in the return increases, the Sharpe ratio also increases in most cases. This risk–return profile can be explained by the shorter converging period in the co-integrated LMAR model and the larger volatility in the ‘mean-reverting’ regime.     

The affine Heston model with correlated Gaussian interest rates for pricing hybrid derivatives

In this article we define a multi-factor equity–interest rate hybrid model with non-zero correlation between the stock and interest rate. The equity part is modeled by the Heston model and we use a Gaussian multi-factor short-rate process. By construction, the model fits in the framework of affine diffusion processes, allowing fast calibration to plain vanilla options. We also provide an efficient Monte Carlo simulation scheme.     

Variance swap dynamics

We compare several parametric and non-parametric approaches for modelling variance swap curves by conducting an in-sample and an out-of-sample analysis using market prices. The forecasted Heston model gives the best overall performance. Moreover, the static Heston model highlights some problems of stochastic volatility models in option pricing of forward starting products.     

Voluntary disclosure practices by foreign firms cross-listed in the United States

This is one of the first large-scale studies to examine the voluntary disclosure practices of foreign firms cross-listed in the United States. We proxy for voluntary disclosure using three attributes of firms’ management earnings guidance: (1) the likelihood of issuance; (2) the frequency of earnings guidance; and (3) a guidance quality measure. After first establishing that market participants view these firms’ disclosures as credible and economically important (i.e., the disclosures are negatively related to analyst forecast errors and the implied cost of equity capital), we compare cross-listed firms’ disclosure practices with comparable US firms and explore variations in disclosure practices among cross-listed firms. We find that cross-listed firms issue less frequent and lower quality management earnings guidance than comparable US firms. We further show that the gap between US and cross-listed firms widened after passage of Regulation FD, a regulation which induced greater public disclosure of firm-specific information. Focusing on the sample of cross-listing firms, we show that firms from common-law countries disclose more than firms from code-law countries. Finally, our results indicate that cross-listed firms that do not list on an organized US exchange provide more frequent and higher quality disclosure than those that do list on organized exchanges.     

Dividends,research and development expenditures,and the value relevance of book value for UK loss-making firms

We extend prior research on the value relevance of accounting information for loss-making firms by allowing the coefficient of book value to vary across three distinct set of loss-making firm observations in our valuation model. Our key findings are, first, that book value is a less important determinant of equity value for either high R&D-intensive firms or dividend-paying firms, relative to firms with low R&D-intensity and zero dividends. Prior literature suggests that book value is a strong indicator of firm value for loss-making firms. This reasoning stems from book value's role as: (i) a proxy for the value of the possibility of abandoning or adapting the firms' net assets; and/or (ii) a proxy for expected future normal earnings. Our work suggests that this prior literature does not fully capture the valuation role of book value for loss-making firms. Second, we also find that dividends are value relevant, but generally only when the valuation role of book value is contextualised by allowing its coefficient to vary across high R&D-intensive firms, and dividend-paying, loss-making firms.     

Drivers of innovation capital disclosure in intellectual capital statements: Evidence from Europe

Innovation is one of the major determinants of competitive success. As a result, there is demand for information on the innovation activities of firms among investors, other stakeholders and the public. Using content analysis, this paper examines the innovation capital disclosure (INCD) characteristics (i.e. disclosure quantity and quality) in the intellectual capital statements (ICS) of 51 European for-profit firms. Additionally, the relationships between INCD characteristics and industry, firm size, region of registered office and the disclosure guidelines adopted are analysed. Our content analysis detects an average of 29.16 items on innovation capital (INC) per ICS. These are mainly qualitative, non-financial and historically orientated. Furthermore, as expected, industry, firm size, region and disclosure guidelines drive the quantity of disclosure. Prior empirical studies of voluntary disclosure in documents other than ICS have also suggested a relationship between firm size and disclosure quality. Interestingly, our results for INCD in ICS do not support this relationship. This provides tentative evidence for a similar qualitative level of innovation capital disclosure across firm size. Furthermore, our findings show mostly homogeneous disclosure patterns across the regions in Europe, suggesting that multinational efforts towards fostering INCD has made the ICS phenomenon more a European than a local phenomenon.     

Forecasting mortality

Abstract

The work of actuaries is concerned with estimating the future on the basis of past experience. The calculation of a premium to be charged for a given risk implies a forecast of the future but so far as mortality is concerned we have generally been content to examine past experience and assume that the results will be repeated. Judged as forecasts our estimates have sometimes been wide of the mark and owing to an almost continuous improvement in mortality actuaries have been assuming heavier rates of mortality than have been experienced. We may defend the use of past experience by saying that it is on the safe side when we are calculating premiums and we may argue that it is the best practical method; but an alternative is to make a more accurate forecast and then allow in our calculations a margin for chance deviations, emergencies, etc. Moreover the assumption that the past will be repeated has not been uniformly safe; it has led to bad results in annuity business and may prove unfortunate in social insurance, pension funds, and even sickness insurance. For some of these purposes we should either work on an estimate of future rates of mortality or, which comes to much the same thing, take a sufficient margin to cover the error involved in our assumptions.     

On distributions of functions of samples from a normally distributed infinite population

Abstract

7. The joint distribution of the moments a ₁₁, a ₂₂,…, a_nn and a ₁₂, …, a _1n may be deduced explicitly in the case, in which the variates χ₁, …, χ _n in (1) are mutually uncorrelated. In this case we have for the population values of the moments: α_μv = 0 for μ ═ v and, consequently, A_μv = 0 for μ ═ v, so that according to (6) λ_μv = 0 for μ ═ v; the distribution (5) of the moments α_μv is then