Derivative Contracts Research Articles

Interest Rate Risk Modelling Using Semi-Heavy Tail Distributions of Normal Variance-Mean Mixtures: A Study on Central Bank of Kenya Interest Rates

Derivative prices such as options and bond prices as well as swaps depend on the distributional assumptions of the underlying economic variables, normally, interest rates. The risk associated with changes in interest rates may worsen the value of the contract that depend on it since the values of these assets (derivative contracts) are affected directly by the fluctuations in interest rates. The distribution of interest rates, therefore, needs to be well understood to reduce the risks of losses associated with it. The Binomial Option pricing model assumes that interest rates are constant throughout the life of the option. Another common assumption of the underlying economic variables is that their returns are normally distributed with constant volatility. These assumptions have been used in pricing derivatives and currencies and has led to over-pricing and in some cases under-pricing. The models of the Normal Variance-Mean Mixtures used in this research shows better performance than the normal distribution. Weekly 91-day and commercial bank interest rates are used from 1991 to 2021. This study will provide a better model for interest rates to avoid mispricing. We find that the 91-day Treasury Bills interest rates follow a Generalized Hyperbolic distribution while the Commercial Bank interest rates follows a Normal Inverse Gaussian distribution. G.A.R.C.H model is then used in forecasting under each of the above findings. A 99pc Value at Risk is then computed for the two models and calculates the minimum expected returns in the subsequent months. This research forms a foundation for the development of advanced pricing models that incorporates the fluctuations of interest rate in the pricing industry. We conclude that the Normal Inverse Gaussian and Generalized hyperbolic distributions provide better fits than the assumed normal distribution.

Arbitrage outcome between conventional and Islamic finance of yield and forward rates in bond market

Purpose In this research, arbitrage opportunity is tested between the yield rates computed by the NSS model, and the computed forward rates between conventional and Islamic finance to see any arbitrage opportunity. The research questions are the conventional and Islamic finance yields at the same level and equal to each other to avoid arbitrage? Whether conventional and Islamic forward rates differ significantly and thus create any arbitrage opportunity. This study aims to find the presence or absence of arbitrage between conventional and Islamic finance yield rates. Design/methodology/approach The NSS model is the latest model in calculating yield and forward rates. In the method the error level is minimized so expected yield rate and given yield rate both converged (Vahidin and Anastasios, 2020). When they converged it gives the researchers all six months’ yield rates. For the Nelson Siegal method, all the six months’ yield rates are available and these yield rates can be used to compute the forward rates. Findings The authors concluded there is a significant difference between the conventional yield rate and the Islamic yield rate. It suggests that because there are significant differences, its suggest arbitrage is possible. So anyone interested in making a guaranteed profit. The conventional yield rates are lower; hence, anyone can borrow from the conventional finance system and invest the money in the Islamic financial system because investments are getting higher rates of income in the form of yield rate in Islamic Finance. So, one can make money because of this difference. Statistically, it is possible to make money, but practically, the authors observed the difference, however it is very meager. The arbitrage opportunity between Islamic finance and conventional finance will not affect the economy because the significant difference is too small. The disturbance in the arbitrage opportunity due to the values is very meager and insignificant. Research limitations/implications This research does not address the derivative contracts’ role in risk management; future researchers could take up this as another research. Practical implications This research will be beneficial for financial institutions, especially institutional investors. Besides, this research will help the regulators and investment bankers in assisting where and future losses especially bond portfolios in conventional finance and Islamic finance. This study will also contribute and help the asset manager of mutual funds in the mutual fund industries. Social implications In effect, this research will strengthen the financial system, capital market and bond market, derivative contracts such as options contracts, futures contracts, swap contracts and forward contracts will use computed forward rates for assessing future losses (value at risk [VaR]) and to hedge them (Balakrishnan, 2020). Originality/value As this topic is rarely studied it will increase the literature present in this domain.

A Robust Numerical Simulation of a Fractional Black–Scholes Equation for Pricing American Options

After the discovery of fractal structures of financial markets, fractional partial differential equations (fPDEs) became very popular in studying dynamics of financial markets. Available research results involves two key modelling aspects; firstly, derivation of tractable asset pricing models, those that closely reflects the actual dynamics of financial markets. Secondly, the development of robust numerical solution methods. Often times, most the effective models are of a nonlinear nature, and as such, reliable analytical solution methods are seldomly available. On the other hand, the accurate value of American options strongly lies on the unknown free boundaries associated with these types of derivative contracts. The free boundaries emanates from the flexibility of the early exercise features with American options. To the best of our knowledge, the approach of pricing American options under the fractional calculus framework has not been extensively explored in literature, and an obvious wider research gap still exist on the design of robust solution methods for pricing American option problems formulated under the fractional calculus framework. Therefore, this paper serve to propose a robust numerical scheme for solving time-fractional Black–Scholes PDEs for pricing American put option problems. The proposed scheme is based on the front-fixing algorithm, under which the early exercise boundaries are transformed into fixed boundaries, allowing for a simultaneous computation of optimal exercise boundaries and their corresponding fair premiums. Results herein indicate that, the proposed numerical scheme is consistent, stable, convergent with order O(h2,k)\\documentclass[12pt]{minimal} \\usepackage{amsmath} \\usepackage{wasysym} \\usepackage{amsfonts} \\usepackage{amssymb} \\usepackage{amsbsy} \\usepackage{mathrsfs} \\usepackage{upgreek} \\setlength{\\oddsidemargin}{-69pt} \\begin{document}$${\\mathcal {O}}(h^2,k)$$\\end{document}, and also does guarantee positivity of solutions under all possible market conditions.

Derivative Pricing using Quantum Signal Processing

Pricing financial derivatives on quantum computers typically includes quantum arithmetic components which contribute heavily to the quantum resources required by the corresponding circuits. In this manuscript, we introduce a method based on Quantum Signal Processing (QSP) to encode financial derivative payoffs directly into quantum amplitudes, alleviating the quantum circuits from the burden of costly quantum arithmetic. Compared to current state-of-the-art approaches in the literature, we find that for derivative contracts of practical interest, the application of QSP significantly reduces the required resources across all metrics considered, most notably the total number of T-gates by ∼16x and the number of logical qubits by ∼4x. Additionally, we estimate that the logical clock rate needed for quantum advantage is also reduced by a factor of ∼5x. Overall, we find that quantum advantage will require 4.7k logical qubits, and quantum devices that can execute 109 T-gates at a rate of 45MHz. While in this work we focus specifically on the payoff component of the derivative pricing process where the method we present is most readily applicable, similar techniques can be employed to further reduce the resources in other applications, such as state preparation.

The Influence of Credit Risk Using Derivative Financial Instruments on the Performance Commercial banks

The research aims to reveal the influence of credit risks using Derivative Financial Instruments (DFIs) on the financial performance of commercial banks in Iraq. To achieve the research aim and test its main hypothesis, a questionnaire is distributed to listed commercial banks in the Iraq Stock Exchange and that apply DFIs. The researcher used the questionnaire as the main tool in collecting data. Financial data of the variables of the study are analysed by a simple regression method, the arithmetic mean(AM) and standard deviation. The study used the statistical program (SPSS ) to analyse the data. The research sample consisted of (70) questionnaire forms that were distributed and (68) valid forms were recovered. Research results show that using DFIs reduces exposure to interest rate risks, exchange rates and price fluctuations. The financial crisis is the result of the excessive use of financial derivatives outside regulatory restrictions and securitization to collect liquidity. Financial derivatives represent the fastest-growing form of financial transactions and continue to grow even in crisis conditions. DFIs help to identify risks associated with economic losses incurred by the economic unit as a result of weaknesses in the management and operation of derivatives contracts. Accounting profit-based performance indicators, such as return on assets, return on property rights, earnings per share and cash flows per share, contribute to the evaluation of performance, as well as the use of DFIs contribute to increasing profits. The study shows that credit risks using DFIs have a significant positive influence on performances financial in commercial banks in Iraq. Paper type: Research paper.

Reconciling Open Interest with Traded Volume in Perpetual Swaps

Perpetual swaps are derivative contracts that allow traders to speculate on, or hedge, the price movements of cryptocurrencies. Unlike futures contracts, perpetual swaps have no settlement or expiration in the traditional sense. The funding rate acts as the mechanism that tethers the perpetual swap to its underlying with the help of arbitrageurs. Open interest, in the context of perpetual swaps and derivative contracts in general, refers to the total number of outstanding contracts at a given point in time. It is a critical metric in derivatives markets as it can provide insight into market activity, sentiment and overall liquidity. It also provides a way to estimate a lower bound on the collateral required for every cryptocurrency market on an exchange. This number, cumulated across all markets on the exchange in combination with proof of reserves, can be used to gauge whether the exchange in question operates with unsustainable levels of leverage, which could have solvency implications. We find that open interest in Bitcoin perpetual swaps is systematically misquoted by some of the largest derivatives exchanges; however, the degree varies, with some exchanges reporting open interest that is wholly implausible to others that seem to be delaying messages of forced trades, i.e., liquidations. We identify these incongruities by analyzing tick-by-tick data for two time periods in 2023 by connecting directly to seven of the most liquid cryptocurrency derivatives exchanges.

The demand for central clearing: To clear or not to clear, that is the question!

This paper empirically analyses whether post-global financial crisis regulatory reforms have created appropriate incentives to voluntarily centrally clear over-the-counter (OTC) derivative contracts. We use confidential European trade repository data on single-name sovereign credit default swap (CDS) transactions and show that both seller and buyer manage counterparty exposures and capital costs, strategically choosing to clear when the counterparty is riskier. The clearing incentives seem particularly responsive to seller credit risk, which is in line with the notion that counterparty credit risk (CCR) is asymmetric in CDS contracts. The riskiness of the underlying reference entity also impacts the decision to clear as it affects both CCR capital charges for OTC contracts and central counterparty clearing house (CCP) margins for cleared contracts. Lastly, we find evidence that when a transaction helps netting positions with the CCP and hence lower margins, the likelihood of clearing is higher.

Significance and perspectives for development of commodity exchange trade in agricultural products

Exchanges are intermediaries in the trade of commodities, financial instruments that have commodities in their base or credit instruments that are secured by commodities. Commodity exchanges have gained in importance in recent decades. Commodity exchanges have evolved from the place where the physical purchase and sale of goods takes place to trade in commodity derivatives where standardized contracts−futures and options−are traded. The role of commodity exchanges in the development of the agribusiness sector has changed significantly from the initial stage of development when in the beginning the main role was to ensure efficient and transparent exchange of commodities, until the early 1970s when instruments were developed to enable risk management in the agribusiness sector. The largest volume of tradе on modern commodity exchanges is realized in standardized derivative contracts. Financial derivatives are one of the most successful financial innovations, with the volume of turnover increasing significantly. Within this chapter, special attention is paid to the analysis of the situation in the field of commodity exchange trading in the Western Balkan region. According to the results of the analysis, developed agricultural commodity exchange trade is not available to the farmers in these countries, nor are business risk management instruments available to participants in countries with developed commodity exchange systems. Analyses have shown that the sole commodity exchange with a significant volume of trade in the countries of the Western Balkans is the Novi Sad commodity exchange, trading on the spot and non‒standardized term market. In terms of the directions of development of regional commodity trade, the experience so far shows that high trading volume is a paramount for well‒developed commodity exchange. Therefore, the path to the development of commodity exchange trading is the establishment of a regional commodity exchange that would be a place of trade for all of the Western Balkan’s countries. By establishing a regional commodity exchange, participants in the agricultural sector would have the opportunity to securely and transparently trade and manage the price risk that have a pronounced volatility in recent years.

Criteria for what makes a local optional martingale a true martingale

What makes an optional stochastic exponential a true optional martingale in a probability space where the underlying filtration is not right continuous nor complete. In this paper, we are going to answer this fundamental question. True martingales play an important role in many applications, just consider the large field of the fair pricing of derivative contracts. Therefore, it is important to give a natural, simple and verifiable condition for having a true martingale property in the context of the theory of optional martingales. The way we have done this here is by extending the method of Beneš to local optional martingales, giving a list of conditions for when an optional stochastic exponential of a local optional martingale is a true optional martingale.

Kepastian Hukum Aset Kripto sebagai Instrumen Investasi dalam Persfektif Hukum Islam dan Hukum Positif

Cryptocurrency is a virtual currency without physical form or concrete existence in the virtual world. One of them is Crypto Assets, which are becoming increasingly popular as a means of online payment, even though the government has banned it. In early 2019, the Indonesian government issued regulations legalizing Crypto Assets in Commodity Futures Trading. The use of Crypto Assets as commodities and exchange tools in online transactions has sparked pros and cons among religious scholars and economic experts. This study aims to determine the status of cryptocurrency as a commodity in Indonesia and the opportunities for Crypto Assets as subjects in Sharia commodities on the Commodity Exchange. The theory used is the theory of valid and invalid business transactions in Islam. This research is a literature study and qualitative in nature. The data analysis technique used is analytical descriptive with a normative juridical Islamic law approach. The research found that cryptocurrency can be traded in Sharia commodity exchanges with the condition that the country must protect the trade with legal umbrella and issue cryptocurrency with its value based on gold or the country's currency. Crypto Assets cannot be used as commodities in Sharia Derivative Contracts in Indonesia because they still contain speculation, maysir, and are vulnerable to being used for illegal activities. Therefore, Crypto Assets are haram due to external factors, so it is best to avoid them.

ВИДИ ТА КЛАСИФІКАЦІЙНІ ОЗНАКИ ДЕРИВАТИВНИХ КОНТРАКТІВ

The article reveals the importance of derivative contracts in the economic system. It was established that the prerequisites for the formation of exchange trading in derivative contracts had a long evolution and development. The views of domestic and international scientists regarding the use of derivative contracts in international practice are considered. It was established that exchange trading in derivative contracts, with its inherent modern features, has been actively taking place on international commodity and stock exchanges for the past two centuries. During this time, a large number of various derivative contracts arose on demand and to meet the needs of participants in market relations. The available classification features of derivative contracts are determined and their systematization and refinement are given. Classification groups of derivative contracts based on various classification features are considered. It was found that scientific and legislative sources contain a large number of classification features for derivative contracts, which contributes to the formation of their functional purpose in stock trading. The available classification features in international and domestic sources are summarized, namely according to: types of basic assets; economic purpose; sphere of circulation; method of execution; method of use; innovative purpose. Based on the generalization of foreign and domestic scientific sources, we have systematized the classification features of derivative contracts, and also taking into account the dynamic development of international exchange trading, we have clarified and proposed a classification feature – "by innovative purpose". In this case, derivative contracts can be divided into: traditional and innovative instruments. Traditional types include classic types of derivative contracts, while innovative types include hybrid types of derivative contracts and new types of underlying assets, such as cryptocurrencies.

ОЦІНКА МІЖНАРОДНОЇ БІРЖОВОЇ ТОРГІВЛІ Ф’ЮЧЕРСАМИ ТА ОПЦІОНАМИ

The article defines the influence of globalization factors on stock exchange conjunctures changes. It was noted that modern international exchange trading is an organized form of trading in derivatives, which include futures contracts and options on future prices. International exchange trading is an important center of global accumulation and redistribution of global investment capital. Increasing the investment attractiveness of exchange instruments contributed to attracting additional international investments to international derivatives platforms. It has been established that, despite the impact of globalization and price volatility, in the last few years, the main international commodity and financial organized markets have seen a systematic increase in the volume of derivative contracts international exchange trade on commodity and financial assets, or more precisely, futures contracts and options on futures prices. Statistical data of analytical studies conducted on the basis of the reports of the Futures Industry Association indicate that only in the last ten years the volume of international exchange trade has increased by 6.3 times. It is noted that international stock trade has undergone drastic changes in the last two centuries, taking into account the types of exchange-traded instruments and the technology of stock exchange trade. As a result, modern international stock exchange trading can be considered a global organized market for the formation of price conditions and the accumulation and transfer of foreign investments. Globalization has provided many positive transformations for international exchange trading. The first and most important of them is the rapid spread of innovations on exchange platforms, and the other is the possibility of attracting a wide range of participants to the electronic exchange processes. Perspective ways include: work on improving the regulation of cryptocurrency exchange trading; development of innovative approaches to the use of АІ in all exchange processes; systematic fight against price instability.

UNITED STATES OF AMERICAbefore theCOMMODITY FUTURES TRADING COMMISSIONIn the Matter of the Certification by KalshiEX LLC of Derivatives Contracts with Respect to Political Control of the United States Senate and United States House of RepresentativesORDER

UNITED STATES OF AMERICAbefore theCOMMODITY FUTURES TRADING COMMISSIONIn the Matter of the Certification by KalshiEX LLC of Derivatives Contracts with Respect to Political Control of the United States Senate and United States House of RepresentativesORDER

Strategy for Effective Claim Management Based on a FIDIC Derivative Contract

Strategy for Effective Claim Management Based on a FIDIC Derivative Contract

Market Risk Management with Equity Derivatives

This case delves into market risk management in an initial public offering (IPO) investment arising due to the unexpected onset of the pandemic. The protagonist in the case is overwhelmed by the euphoria surrounding the IPO issue of SBI Cards and turns into a speculator instead of a normal investor. He makes a leveraged bet on the likely listing gains by resorting to IPO funding. After the closure of the IPO issue, the market registered very sharp declines due to a viral fever engulfing the whole world. Now, the protagonist, who has already lost heavily from the existing portfolio, has to encounter likely losses from the loan-funded IPO investment. He had to hedge the likely losses from the possible listing day losses from the IPO. For this, he needs to put in place a hedging strategy, answering the questions on the choice of derivative contract, size and expiry date of the contract.

A comparison of machine learning and econometric models for pricing perpetual Bitcoin futures and their application to algorithmic trading

AbstractBitcoin (BTC) perpetual futures contracts are highly leveraged speculative trading instruments with daily market trading of $45 Billion. BTC perpetual futures are derivative contracts, which depend upon the underlying BTC SPOT (current) price. Pricing perpetual futures fairly is hard, using traditional arbitrage arguments, because of the volatile nature of the so called funding rate, which is used as the replacement of risk free rate in the Cryptocurrency market. This work presents a novel technique for pricing BTC futures contracts using conditional volatility and mean models. Intra‐day high‐frequency futures' return volatility and mean are modelled using different ML and econometric techniques. A comparison is made using statistical measures to find the model that best captures the intra‐day conditional mean and volatility. Exponential generalized autoregressive conditional heteroskedasticity is shown to be an almost unbiased predictor of intra‐day volatility, while a constant autoregressive moving average (0, 0) model best captures the conditional mean of the returns. A market directional high frequency trading algorithm is developed using the volatility and mean models. The algorithm first prices the futures contract at some future point of time using the volatility and mean regression models. Next, the slope between the current futures price and the expected price are used to predict the market direction. A long or short position is taken depending upon the expected market direction movement. Extensive back‐testing results show absolute returns of 1500%–8000% depending upon the transaction fees and leverage used. On average, the market direction is predicted correctly 85% of the time by the best model. Finally, the trading technique is market neutral, in that it gives large positive returns, with low SD, in both bull and bear markets.

Dynamic bid–ask pricing under Dempster-Shafer uncertainty

We deal with the problem of pricing in a multi-period binomial market model, allowing for frictions in the form of bid–ask spreads. We introduce and characterize time-homogeneous Markov multiplicative binomial processes under Dempster-Shafer uncertainty together with the induced conditional Choquet expectation operator. Given a market formed by a frictionless risk-free bond and a non-dividend paying stock with frictions, we prove the existence of an equivalent one-step Choquet martingale belief function. We then propose a dynamic Choquet pricing rule with bid–ask spreads showing that the discounted lower price process of a European derivative contract on the stock is a Choquet super-martingale. We finally provide a normative justification in terms of a dynamic generalized no-arbitrage condition relying on the notion of partially resolving uncertainty due to Jaffray.

The development of an insolvency privilegle for derivatives in German law

The article outlines the development of insolvency privilege with respect to derivatives under German law in its historical perspective. It traces the evolution of special privilege from the moment when it was first announced in the German insolvency statute (Insolvenzordnung) and came into force on August 1, 1994, up to the moment when legislative provisions securing the functioning of derivatives in insolvency context were amended in response to the 2016 Federal Court of Justice Verdict. This court ruling ended the long-standing consensus on “friendliness” of the German insolvency law to derivatives and other financial transactions. German highest court concluded that contractual clauses on the termination of obligations under derivative contracts in the event of bankruptcy are invalid unless their legal result is identical to the one prescribed by law. This court decision created significant legal uncertainty for recognition of claims under derivative transactions and directly influenced the use of standard master agreement for over-the-counter derivatives. Drafted under the auspices of the German Banking Union (GBU), an organization representing the interests of German financial institutions, German Master Agreement for Financial Derivatives Transactions ( Deutscher Rahmenvertrag fur Finanztermingeschäfte ) provided a contractual framework for the relevant market, and it came under significant pressure. Overall, German insolvency rules were significantly enforced to achieve the enforceability of close-out netting thus expanding the insolvency privilege for derivative transactions.

A Study to Identify the Commodity Characteristics towards A Potential Derivative Contract on Tea

A Study to Identify the Commodity Characteristics towards A Potential Derivative Contract on Tea

A Study to Identify the Commodity Characteristics towards A Potential Derivative Contract on Tea

In this study, we examine the determinants of a successful derivative futures contract and explore whether an exhaustive checklist of criteria such as the one proposed by the Securities and Exchange Board of India (SEBI) guarantees the success of a commodity contract. This study has important implications for contract design and new product launches. More market-orientated risk management mechanisms such as hedging via derivatives could allow farmers and producers to manage their risk and efficiently discover true prices. The government's vision to develop a progressive and sustainable commodities market in India is facing a fundamental issue: What makes a futures contract successful? This study attempts to analyse this question. Academics and policymakers have long deliberated on the conditions that make a contract successful. This study revisits those conditions in the context of Indian agricultural futures contracts and assesses the dispositions made by the SEBI’s long list of criteria as well as insights from prior studies about the determinants of a successful contract. Tea satisfies almost all the criteria with either first or second rank among the three compared products. Therefore, we can conclude that Tea has the necessary and potential characteristics for introduction in the Commodity Derivative Market of India and progress forward as a successful commodity