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Macroeconomic Announcements and Risk Premia in the Treasury Bond Market

This paper investigates whether innovations in macroeconomic variables are priced factors for Treasury bond returns. Economic intuition would suggest that this should be the case. However, for both equity and bond returns, it has been challenging to obtain robust findings. Higher frequency data than the monthly or quarterly frequency used in the literature will be used in this study. I will focus on Government bond returns.

Ebook Implied and Realized Volatility: Empirical Model Selection

It is commonly known that volatility can either be estimated through the past variation of the price process of an underlying asset, or be imputed through a derivative pricing model. The former approach delivers the realized or historical volatility, and the latter gives the implied volatility. In the Black and Scholes (1973)-Merton (1973) model, both volatilities represent the same object, the variations of the returns in the underlying security. However, it is rare that realized and implied volatility agree in practice.

Stock Option Expense, Forward-looking Information, and Implied Volatilities of Traded Options

There is no shortage of theoretical models of employee stock option (ESO) value in the academic literature (see, e.g., Hemmer et al. 1994, and Carpenter 1998). Still, for a variety of reasons (e.g., the difficulty in assessing the empirical validity of these models) many firms use the Black-Scholes model to value their ESO, although ESO clearly violate important assumptions underlying this model (e.g., Black-Scholes assumes a diffusion process and values European calls, whereas in reality stock prices may jump and nearly all ESOs are American calls).

How Asymmetric Is U.S. Stock Market Volatility?

It is well established that positive and negative return shocks have different impacts on US stock market volatility specifically that volatility is much higher following negative return shocks than following positive return shocks of the same magnitude. This has been documented repeatedly by estimations of asymmetric time series GARCH type models, such as the Nelson’s (1991) EGARCH model or the GJR model of Glosten, Jagannathan, and Rungle (1993). It has also been found in the behavior of implied volatility, specifically the CBOE’s VIX index. However, the extent of this asymmetry and its exact form for the aggregate US stock market are not settled.

Equity Risk and Treasury Bond Pricing

We study whether changes in equity risk can be tied to changes in the slope of the Treasury term structure over the intriguing 1997 to 2007 period. To evaluate the change in the term-structure's slope, we examine both the change in the second principal component derived from the term structure and the change in a `10-year minus 6-month' term yield spread.

Equity Style Returns and Institutional Investor Flows

Investors use concepts of investment styles to characterize their portfolios and patterns of trade. Popular styles (e.g., technology stocks, growth stocks, cyclical stocks, etc.) are widely followed both because they help summarize what happened in the marketplace, and because they represent factors across which investors attempt to diversify. Investment fund mandates often explicitly designate style exposures.

Dynamic Mean-Variance Asset Allocation

The mean-variance analysis of Markowitz (1952) has long been recognized as the cornerstone of modern portfolio theory. Its simplicity and intuitive appeal have led to its widespread use in both academia and industry. Originally cast in a single-period framework, the mean-variance paradigm has no doubt also inspired the development of the multi-period portfolio choice literature.

Option market making under inventory risk

We study the optimal bid and ask prices at which an options dealer, or market maker, sets his quotes. The market maker is committed to dynamically update bid and ask quotes in the options market, and is thus at the heart of the option pricing problem. By understanding the dealer’s sources of risk and return, we may formulate his “optimal” quoting policy and thus gain insight in the dynamics of option prices.

Implied Market Price of Weather Risk

Weather influences our daily lives and has an enormous impact on corporate revenues and earnings. The global climate changes the volatility of weather and the occurrence of extreme weather events increases. Adverse and extreme natural events like hurricanes, long cold winters, heat waves, droughts, freezes, etc. may cause substantial financial losses. The traditional way of protection against unpredictable weather conditions has always been the insurance, which covers the loss in exchange for the payment of a premium. However, recently have become popular new financial instruments linked to weather conditions: CAT bonds, sidecars and weather derivatives.

Bank Loan Supply, Lender Choice, and Corporate Capital

Do shocks to particular suppliers of capital affect corporate capital structure decisions? Previous research has shown that frictions in the credit creation process lead to fluctuations in the supply of bank loans. Further, the presence of informational asymmetries creates variation in firms' access to non-bank capital sources.

Bank Capital, Agency Costs, and Monetary Policy

A large body of literature analyzing the quantitative importance of agency costs in otherwise standard business cycle models has recently emerged. Originating in the theoretical contributions of Williamson (1987) and Bernanke and Gertler (1989), this literature is exempli ed by Carlstrom and Fuerst (1997, 1998, 2001) and Bernanke et al. (1999).

The Real Effects of Banking Shocks: Evidence from OECD Countries

The recent financial crisis has exposed the global banking system to a series of adverse shocks. The crisis started with a substantial fall in the value of mortgage-related securities which inflicted heavy losses on the banking sector. In some countries, a liquidity crisis has developed as uninsured deposits were suddenly withdrawn, which intermittently led to bank failures.

Stomach Cancer

This booklet has been written to help you understand more about cancer of the stomach. We hope it answers some of the questions you may have about its diagnosis and treatment.

Liquidity, Asset Prices, and Credit Constraints

The provision of credit helps to satisfy people's need to finance unanticipated consumption or investment. Credit provision is often constrained if lenders cannot force borrowers to repay their debts, unless the debts are secured. We consider an economy with such a feature, where financial assets are used as collateral to secure loans, to study the interaction between the asset prices, credit constraints, and aggregate liquidity.

Corporate Defaults and Large Macroeconomic Shocks

Traded credit risk products have been one of the biggest growth areas in recent years. An accurate forecast of the probability of default (PD) of companies is one of the key variables for pricing these products. PDs have received a lot of attention from a capital setting perspective as well as banks can use their own PD estimates as input for regulatory capital under the new Basel II rules. Basel II also requires banks to stress test their credit portfolios. Essentially, a stress test is a forecast of how a shock to a systematic risk factor will impact on future losses. Conceptually, stress tests are similar to out-of-sample forecasting exercises. But, there is one key difference: the “out-of-sample” nature of a stress test lies in the consideration of large shocks to the predictor variables.

Primary Commodity Prices: Co-movements, Common Factors and Fundamentals

Movements in commodity prices matter for countries’ external and internal balances as well as their respective fiscal and monetary policies. It is therefore not surprising that the nature of such movements, and their determinants, have attracted so much attention in both academic and policy circles. Earlier research focused on the historical trends of primary commodity prices relative to the price of manufactured goods in the examination of the Prebisch (1950) and Singer (1950) hypothesis, as recently revisited by Harvey et al. (2010).

Macroeconomic uncertainty and credit default swap spreads

Over the past decade, the market for credit derivatives has grown tremendously, with the total outstanding notional amount exceeding 62 trillion US dollars by the end of 2008. The credit default swap (CDS), the most commonly-used credit derivative instrument, has enabled investors to insure against a credit event such as the default of a reference entity (e.g., a bond issuer).

Optimal Interest Rate Rules, Asset Prices, and Credit Frictions

In this paper we study optimal Taylor-type interest rate rules in an economy with nominal rigidities and credit market imperfections. Our interest is twofold. First, we aim at driving the attention of the recent literature on a typology of market distortions whose role has been largely neglected in the normative analysis of monetary policy.

Optimal Allocation to Hedge Funds : An Empirical Analysis

One of the by-products of the bull market of the 90’s has been the consolidation of hedge funds as an important segment of financial markets. The value of the hedge fund industry worldwide is estimated at more than 500 billion dollars distributed among over 5,000 hedge funds. The majority of institutional investors seems to be moving towards holding hedge funds in their portfolios.

Liability Valuation and Optimal Asset Allocation

This paper deals with liability valuation and optimal asset allocation and the key word is the conjunctive ‘and’. Both in practice and in the theoretical literature, liability valuation and asset allocation are typically treated as completely separate issues, despite lip service to the con-trary. A classic example is defined benefit pension fund liabilities and assets.

Operating Risk, Information Risk, and Cost of Capital

Prior research suggests that residual accruals volatility is a measure of a firm’s accruals quality, earnings quality, or overall information quality. We re-assess recent studies that suggest that residual accruals volatility captures information risk and is related to a firm’s cost of capital. For example, Francis, LaFond, Olsson and Schipper (2005) test the joint hypothesis that residual accruals volatility captures information risk and that information risk affects a firm’s cost of capital.

Stock Market Bubbles, Fundamentals and Asymmetric Volatility

Understanding the behavior of the variance of stock returns is of great significance for two main reasons. One is the volatility of stock returns plays a central role in capital asset pricing and pricing of contingent claims such as options. The other is the changes in market volatility can have important effects on firms fixed investment and consumptions.

Sources of Financial Flexibility: Evidence from Cash Flow Shortfalls

In imperfect capital markets, financial flexibility i.e., the ability to respond in a timely and value maximizing manner to unexpected changes in cash flows and investment opportunities is valuable. Consequently, in the presence of such imperfections, firms can be expected to choose financial policies that preserve the flexibility to respond to unexpected periods of insufficient resources. In fact, the CFOs surveyed in Graham and Harvey (2001) state that financial flexibility is the most important determinant of capital structure.

Bank Capital, Firm Liquidity, and Project Quality

The link between banks’ financial health and aggregate economic activity is regarded as an important propagation mechanism of recent crises (Texas, 1985-1987; New England, 1991-1992; Nordic countries, 1990-1994; South East Asia, 1997-1998). During these crises, banks suffered large loan losses and were allegedly forced to contract loans to keep complying with regulatory capital requirements. On the real side, many entrepreneurs were unable to obtain alternative financing and had to scale down production (Harris, Boldin and Flaherty, 1994; Peek and Rosengren, 2000).

Credit Market Conditions and Economy-wide Consequences of Financial Reporting Quality

Economic theory suggests that problems due to information asymmetry between borrowers and lenders can have economy-wide consequences by magnifying and prolonging the negative effects of an economic downturn (Bernanke 1983; Bernanke and Gertler 1989). Prior literature refers to this effect of information asymmetry as the financial accelerator effect and argues that this effect influences the magnitude of a business cycle and is an important determinant of a financial crisis (Bernanke et al. 1996; Mishkin 1997).

Operating Leverage, Stock Market Cyclicality, and the Cross-Section of Returns

Ever since Fama and French (1992) showed that firms with high ratios of book value to market value have high average returns, the economic interpretation of their finding has remained elusive. Is book-to-market really an indicator of firm riskiness, if so why? In this paper, I consider the asset pricing implications of a putty-clay technology: capital and labor are substitutable only exante (i.e., before capital investment is done). I show that under this technology, book-to-market differences reflect differences in labor productivity, which result in different exposures to business cycle risk.

Labor Market Dynamics under Long-Term Wage Contracting

In recent years significant research effort has been devoted to trying to understand the sources of the strong cyclical volatility of unemployment in the US. The standard tool for modeling unemployment, the Mortensen-Pissarides search and matching model (Pissarides 1985), produces significantly smaller variation in unemployment than observed (Shimer 2005a).

Wages, Business Cycles, and Comparative Advantage

One of the big puzzles in macroeconomics has been that total hours vary greatly over the business cycle without much variation in wages. The equilibrium approach to economic fluctuation pioneered by Lucas and Rapping (1969) and put forward by Kydland and Prescott (1982) and Long and Plosser (1983) views the variation of total hours of work as people’s willingness to intertemporally substitute leisure and work over the business cycle. As Barro and King (1984) illustrate, under standard preferences the equilibrium business-cycle models require a strongly pro-cyclical real wages to be consistent with the movement in hours and consumption in the data.

Optimal asset allocation in a stochastic factor model - an overview and open problems

The aim herein is to present an overview of results and open problems arising in optimal investment models in which the dynamics of the underlying stock depend on a correlated stochastic factor. Stochastic factors have been used in a number of academic papers to model the time-varying predictability of stock returns, the volatility of stocks as well as stochastic interest rates (see, for example, [1], [15], [42] and other references discussed in the next section). The performance of the investment decisions is, typically, measured via an expected utility criterion which is often formulated in a finite trading horizon.

Strategic Asset Allocation and Consumption Decisions under Multivariate Regime Switching

For most investors the strategic asset allocation decision how much to invest in major asset classes such as cash, stocks and bonds is a key determinant of their portfolio performance. The importance of this decision has further been highlighted by empirical findings suggesting that stock and bond returns contain a sizeable predictable component that introduces time-variations in investment opportunities and gives rise to a large hedging demand for multiperiod investors.

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