Derivative Securities Research Articles

Dimension reduction for Quasi-Monte Carlo methods via quadratic regression

Quasi-Monte Carlo (QMC) methods have been gaining popularity in computational finance as they are competitive alternatives to Monte Carlo methods that can accelerate numerical accuracy. This paper develops a new approach for reducing the effective dimension combined with a randomized QMC method. A distinctive feature of the proposed approach is its sample-based transformation that enables us to choose a flexible manipulation via regression. In the proposed approach, the first step is to perform a regression using the samples to estimate the parameters of the regression model. An optimal transformation is proposed based on the regression result to minimize the effective dimension. An advantage of this approach is that adopting a statistical approach allows greater flexibility in selecting the regression model. In addition to a linear model, this paper proposes a dimension reduction method based on a linear-quadratic model for regression. In numerical experiments, we focus on pricing different types of exotic options to test the effectiveness of the proposed approach. The numerical results show that different regression models are chosen depending on the underlying risk process and the type of derivative securities. In particular, we show several examples where the proposed method works while existing dimension reductions are ineffective.

PROBLEMS AND PROSPECTS OF FINANCIAL DERIVATIVES MARKET DEVELOPMENT

The article studies the problems and prospects of the financial derivatives market development. Globalizing the economic space contributes to transforming the stock market into the principal source of capital allocation. Still, the current conditions of the derivatives market in Ukraine do not correspond to the needs of the national economy, which requires strengthening the regulation of their activities to ensure the hedging of risks of market participants. The article analyses the dynamics of derivatives trading in the global exchange market, assesses the dynamics of world exchange trading in financial derivatives, and analyses the turnover of OTC derivatives in the EU. It also studies the dynamic changes in the amounts paid under the terms of contracts for derivative securities in the world by maturity, region and industry sector; the dynamics of options and futures trading in the global exchange market. In this analysis, we examine the trading volumes of derivatives within the financial market of Ukraine. We estimate the volume of trading within both exchange and over-the-counter markets, and present the dynamics of exchange contracts as well as the share of financial instrument trading in the securities market. The factors hindering the development of the derivatives market in Ukraine are identified. These factors include legislative shortcomings, the current level of derivatives market infrastructure, and the current state of development of the underlying asset markets. The article also analyses the derivatives market and provides prospects for its development. To ensure the future development of the financial derivatives market in Ukraine, it is essential to take certain measures. These include comprehensive regulation of the derivatives market, ensuring the operation of regulated markets and building their infrastructure, and introducing appropriate instruments to protect participants and hedge risks.

Risk Premium and Volatility Analysis on Indonesia Stock Exchange

Market risk premium and market volatility are important in investment decisions. Volatility is an important variable in derivative securities which is a measure of changes in stock returns. The research focuses on stock return volatility, research that points to a risk premium in emerging markets. The purpose of this study is to explain the relationship between market equity premium and volatility using GARCH (1.1) on the Indonesia Stock Exchange. This research uses daily closing price data of the Indonesia Stock Exchange Composite Index (JCI). The result of this study, that there is a relationship between risk premium and volatility in the Indonesian stock market. The conclusion of this study is to try to test whether there is a relationship from the volatility of return to risk premium in the Indonesian stock market. Using the daily trend of the Indonesian stock market (IDX) from January 2010 to September 2023.

Main problems of the derivatives market in Ukraine and ways to solve them

This article highlights one of the key problems of the financial market of Ukraine – the development of the derivative securities market. The relevance of the study of the problems of the market of derivative financial instruments based on the example of Ukraine is substantiated. Special attention is paid to the study of the scientific works of Ukrainian researchers and scientists, their results and the significance of these works for Ukraine. The article also highlights interesting approaches and relevant information on the basis of which this research was conducted. The main types of derivative securities (forward and futures contracts, options, swaps and warrants) and their key features are characterized – essence, terms of conclusion, functions and significance for the market, roles of participants in these operations, etc. The use of these derivatives is explained, with advantages and disadvantages indicated. The principles of the functioning of the derivatives market in Ukraine are also described and researched, the main types of derivatives concluded on the Ukrainian financial market over the past few years and the prevailing trends in this area are mentioned. With the use of statistical data and comparative analysis, the dynamics of the main indicators of the Ukrainian derivatives market were studied, compared with some indicators inherent in the world derivatives market, and graphically interpreted. With the help of general scientific methods of synthesis, induction and deduction, the main differences between the indicators of the Ukrainian and world markets of derivative financial instruments, as well as possible reasons for their appearance, were determined. The main internal shortcomings of the derivative securities market in Ukraine are highlighted. The influence of the mentioned shortcomings was studied, the negative consequences of the pandemic and full-scale war on the dynamics of these indicators were proved. In contrast to the described shortcomings, attention is focused on successful participants of the derivative securities market and the results of their activities. Key trends were also displayed graphically. In conclusion, the intended strategy of our state in solving the existing problems of the derivatives market is described, and its own ways of solving them and accelerating the development of the derivative financial instruments market in Ukraine are proposed.

Calculation Option Price on Shares PT. Nippon Indosari Corpindo Tbk. with Fuzzy Binomial Tree Model

The Cox-Ross-Rubinstein binomial tree model is widely used in stock and derivative securities calculations, such as options calculations. The binomial CRR model assumes that the parameter increases in option prices and decreases in option prices so this model produces stock price movements up and down stock price movement. However, stock price movements show price fluctuations and cause the volatility of the value to be unsuitable. In this study, modeling stock and option price movements using a fuzzy binomial tree model. The data used was data on the movement of the stock price of Nippon Indosari Corpindo Ltd Plc from February 2021 to January 2022. The results showed that for February 2022, with a risk size of 90%, the selling price options with the greatest volatility of 51.6484081, medium volatility of 33.33154354, and the smallest volatility of 28.17155892.

Option Pricing and Risk Hedging in the Current Financial Market: A Case for Google

In the past few decades, financial derivative securities have been developing rapidly around the world, and the issue of options and investment consumption has attracted more and more attention from mathematicians and financiers at home and abroad. In this paper, option pricing models are constructed and calibrated based on the Black Scholes Merton model, binomial tree model, historical data model and Monte Carlo diffusion model. The differences between different option pricing models for options and stock hedging of the same company in a short period of time are discussed and analyzed. In this article, the Monte Carlo model outperforms the traditional Black Scholes Merton model, while the binomial tree model and the historical data model do not perform well. The results of this paper are beneficial for investors to use the optimal model to predict option prices, weaken the aggregate risk, and improve the aggregate return level.

A Virtual Trading Project for the Derivative Securities Course

In this paper, I present a simulated trading project for the undergraduate Derivative Securities course which allows students to realistically trade both Futures and Option contracts. The project makes use of the Virtual Trading tool provided on the Chicago Board Options Exchange website, which processes virtual trades in real time using actual market data. Student response to the project's first implementation in Fall 2008 has been overwhelmingly positive. I provide Likert-style survey results describing students' perceptions of various aspects of the assignment, and identify directions for potential future modifications.

A reality check on the GARCH-MIDAS volatility models

We employ a battery of model evaluation tests for a broad set of GARCH-MIDAS models and account for data snooping bias. We document that inferences based on standard tests for GM variance components can be misleading. Our data mining free results show that the gain of macro-variables in forecasting total (long-run) variance by GM models is overstated (understated). Estimation of different components of volatility is crucial for designing differentiated investing strategies, risk management plans and pricing derivative securities. Therefore, researchers and practitioners should be wary of data-mining bias, which may contaminate a forecast that may appear statistically validated using robust evaluation tests.

On Valuation and Investments of Pension Plans in Discrete Incomplete Markets

We study the valuation of a pension fund’s obligations in a discrete time and space incomplete market model. The market’s incompleteness stems from the non-replicability of the wage process that finances the pension plan through time. The contingent defined-benefit liability of the pension fund is a function of the wages, which can be seen as the payoff of a path-dependent derivative security. We apply the notion of the super-hedging value and propose its difference from the current pension’s fund capital as a measure of distance to liability hedging. The induced closed-form expressions of the values and the related investment strategies provide insightful comparative statistics. Furthermore, we use a utility-based optimization portfolio to point out that in cases of sufficient capital, the application of a subjective investment criterion may result in heavily different strategies than the super-hedging one. This means that the pension fund will be left with some liability risk, although it could have been fully hedged. Finally, we provide conditions under which the effect of a possible early exit leaves the super-hedging valuation unchanged.

Abnormal Returns From Hedging, Firm Size, and the Fama and French Multifactor Models

I use the Fama and French (2015) five-factor model to reexamine the seemingly anomalous result of Nelson, Moffitt, and Affleck-Graves (2005), who document significant positive abnormal returns for firms that hedge. Contrary to their results, using the five-factor model on a new sample of U.S. firms from 2013 – 2021, I observe significant negative monthly abnormal returns of -0.190% (-2.26% annually) for firms using derivative securities (hedgers). My result is consistent with poorly diversified managers engaging in costly hedging behavior that benefits management at the cost of shareholders. When I divide the sample by size (total assets), I find that the significant negative abnormal returns are confined only to large firms, offering no support for the economies of scale or managerial sophistication hypotheses.

Progress of the Study on the Models of Option Pricing

Option pricing, a core part of options trading, has been fruitfully researched over the years. This article reviews the history of the emergence and advancement of option pricing in terms of a thorough classification of the widely used option pricing models and their empirical studies that follow. The three option pricing models are summarized, including the Black-Scholes pricing model, the tree diagram model, and the Monte Carlo simulation techniques, which have all represented significant progress in the field of option pricing theory. Moreover, the differences between various pricing models are analyzed and compared to show their applications and to provide an outlook on future work in this theory. It is vital to carry out some research on option pricing in order to better suit the preferences of investors. In order to meet the continuous development of financial markets, valuation of financial derivative securities is the key to effective investment in risky assets.

Optimal measure preserving derivatives revisited

AbstractThis article clarifies the relationship between pricing kernel monotonicity and the existence of opportunities for stochastic arbitrage in a complete and frictionless market of derivative securities written on a market portfolio. The relationship depends on whether the payoff distribution of the market portfolio satisfies a technical condition called adequacy, meaning that it is atomless or is comprised of finitely many equally probable atoms. Under adequacy, pricing kernel nonmonotonicity is equivalent to the existence of a strong form of stochastic arbitrage involving distributional replication of the market portfolio at a lower price. If the adequacy condition is dropped then this equivalence no longer holds, but pricing kernel nonmonotonicity remains equivalent to the existence of a weaker form of stochastic arbitrage involving second‐order stochastic dominance of the market portfolio at a lower price. A generalization of the optimal measure preserving derivative is obtained, which achieves distributional replication at the minimum cost of all second‐order stochastically dominant securities under adequacy.

Limits of Arbitrage and Primary Risk-Taking in Derivative Securities

Abstract Classic option pricing theory values a derivative contract via dynamic delta hedging and treating the contract as redundant relative to the underlying security. Dynamic delta hedging proves highly effective in practice, but the remaining risk is still large because of the practical limits of arbitrage. Derivatives can play primary roles in risk allocation. This paper quantifies the percentage variance reduction of delta hedging on U.S. stock options, proposes a top-down return attribution framework to identify the remaining risk sources of the delta-hedged option investment, and constructs a statistical return factor model to explain the variations of the delta-hedged option returns. (JEL C13, C51, G12, G13)

PROBLEMS AND PROSPECTS OF FINANCIAL DERIVATIVES MARKET DEVELOPMENT

The article is devoted to the study of problems and prospects for the development of the financial derivatives market. The relevance of the chosen topic is explained by the fact that the globalization of the economic space contributes to the transformation of the stock market into the main source of capital allocation, but the current conditions of the derivatives market in Ukraine do not meet the needs of the development of the national economy, which requires strengthening the regulation of their activities in order to ensure the hedging of the risks of market participants. The object of research is financial derivatives as a source of attracting additional investments and globalization of financial flows. The purpose of the research is to study the features, advantages and disadvantages of derivative financial instruments, to evaluate the possibilities of their use in different price situations in order to increase the efficiency of the derivatives market in Ukraine. Research methods – method of system analysis, method of analysis and synthesis, method of statistical analysis and method of comparison. In the course of the study, the dynamics of derivatives trading on the global stock market were analyzed and the dynamics of global exchange trading of financial derivatives were assessed, and the turnover of OTC derivative financial instruments in the EU countries was analyzed. Dynamic changes in the sums paid under the terms of the contracts for derivative securities in the world in terms of terms of validity, regions and sectors were also investigated; dynamics of options and futures trading on the global stock market. In the financial market of Ukraine, an analysis of the volumes of derivatives trade was carried out, the volume of trades on the exchange and over-the-counter markets was estimated, the dynamics of the volumes of exchange contracts and the share of trades in financial instruments on the securities market were given. Factors restraining the development of the derivative securities market in Ukraine have been identified, namely: deficiencies in legislation, the level of development of the infrastructure of the derivative securities market, as well as the current state of development of the underlying asset markets. Based on the analysis of the derivative financial instruments market, prospects for its development have been developed. Conclusions – the main measures regarding the future development of the financial derivatives market in Ukraine should be: comprehensive regulation of the functioning of the derivatives market, ensuring the operation of regulated markets and developing their infrastructure, introducing appropriate tools for the protection of participants and risk hedging. On the basis of taking into account the international experience of the use of derivatives in Ukraine, it is necessary to create an effective developed financial market, and such a segment of it as the derivatives market, in order to become a worthy competitor on the global financial market.

Analysis of Inflation, Interest Rate, Exchange Rate and Real Estate Residential Property Prices, Kenya

Real estate as an investment has continued to form an important part of investments held by both retail and institutional investors over the years. This has been attributed to its ability to generate continuous income streams and capital appreciation of the underlying asset. The Kenyan population is expected to hit 60 Million in 2030, with more than 50% expected to reside in urban areas. This, compounded by the higher-than-average returns experienced in the real estate sector, makes real estate an important investment for investors' portfolios. For instance, one Million invested in 2017 in the real estate sector would have been worth 9.61 Million in 2021, which is higher than that for bonds and equities. Notwithstanding this impressive return component, real estate investments in Kenya have faced challenges such as increased cost of credit through fluctuating interest rates owing to residential real estate being mostly financed by debt. Hence, unstable interest rates affect their market prices. Real estate residential investment has been susceptible to booms and busts and erratic exchange rates, which affect the value of investments made by both local investors and remittances from abroad from time to time which results in either inflated property prices which get out of reach of common retail investors or lack of demand for investors in a market facing a glut. Over the years, inflation has been rising steadily, with each investor becoming more interested in how this might affect their real return. Real estate, which is heavily leveraged, has also been prone to changes in the interest regime in the economy, which affects the cost of borrowing. The study concentrated on inflation, the interest rate regime, and the state of the exchange rate and drew conclusions while referencing finance and economic theory. The study established that a percentage increase in inflation results in a 2.248% increase in real estate residential property prices. On the other hand, a percentage increase in interest rate results in a 9.630% increase in real estate residential property prices. The study also establishes that real estate residential property prices have a negative relationship with exchange rates. Whereby a percentage increase in exchange rate results in a -1.995% decrease in real estate residential property prices in the long run. The study, therefore, recommends the inclusion of real estate investments in investors' portfolios to hedge against inflation and, at the same time, ensures that investors limit interest-sensitive asset classes such as fixed-income securities in portfolios containing residential real estate exposures. Lastly, the study recommends that investors use derivative securities such as futures contracts to hedge against adverse exchange rate movements in real estate residential properties that have exposures .in the foreign exchange markets either through foreign-denominated leases or rental contracts.

Malliavin Derivatives of Derivative Securities

The Malliavin calculus has been used successfully to derive efficient formulas for delta and gamma. This article extends these results to all higher-order spatial derivatives with respect to the underlying asset for arbitrary payoffs in both the Black-Scholes (Black and Scholes 1973) (lognormal) and Bachelier (normal) models. The former reproduces a well-known result from Peter Carr (2000), whereas the latter extends this work to the normal case.

Problematic aspects of derivative financial instruments’ legal regulation

The development of fully functioning capital markets is an extremely important task at the current stage of development of the Ukrainian economy. With the adoption of the Law of Ukraine «On Capital Markets and Organized Commodity Markets», the issue of comprehensive regulation of the functioning of modern financial instruments would seem to have been resolved. However, the analysis of the current legislation regulating derivative financial instruments shows a number of problematic aspects of their legal regulation. It hasbeenestablished that legal regulation of the market of derivative financial instruments, despite the amendments in the legislation, still contains significant gaps, which generally have a negative effect on the regulation of these financial instruments, create obstacles for the formation of trust by investors, which makes them unattractive for investment. Their fragmented legislative regulation is based on contradictory approaches both to the definition of the categorical apparatus and to the types of derivative financial instruments. The outlined problem negatively affects the active development of the derivative instruments market and creates conditions for abuse by emitters of derivative financial instruments.
 The authorshaveindicated that there is a sufficient number of works at the theoretical and legal level, the subjectmatterof which was the study of derivative financial instruments, but the issue of legal regulation of derivative instruments is gaining significant relevance in regard to: changes in the capital market situation; update of existing and introduction of new financial instruments; development of the market of derivative financial instruments that allow us to hedge risks associated with changes in exchange rates or interest rates by means of concluding various types of fixed-termagreements with derivative securities and derivatives. The spread of the use of derivative financial instruments in Ukraine is the key prerequisite for the effective implementation of the process of integration of Ukrainian financial market into the world economy and international financial markets.

REFLECTIONS ON EDITING THE JOURNAL OF FUTURES MARKETS AND FACTORS INFLUENCING DERIVATIVES MARKETS RESEARCH

The Journal of Futures Markets is the leading academic journal specializing in publishing scholarly research on derivative securities and markets. I had the privilege of serving as Editor of the Journal of Futures Markets for 24 years. That position provided me with a catbird seat with which to view the evolution of the financial-economic literature on derivative securities and markets. It also provided me with an opportunity to reflect on how changes in derivative securities and markets, have influenced research. These include the influence of technological advances; changes in market microstructure; financial crises; the growth of derivatives markets in emerging economies; the introduction of credit default swaps, VIX derivatives, cryptocurrency derivatives; and other new products; among others. Although my reflections on the impact of market events on derivatives research is the principal focus of this paper, I want to preface that discussion with some comments on the editing process and the influence of my education, research, and experience on my role as an Editor.

Short selling and options trading: A tale of two markets

AbstractRecent research documents both short selling and option volume are predictive of future real estate investment trust (REIT) returns, suggesting informed investors exploit their informational advantage in both the traditional equity and derivative security markets. However, little work has explicitly examined the factors influencing which of these markets informed investors choose to engage when transacting. We address this gap in the literature and find clear evidence that the risk associated with short selling is a significant driver of this decision. Specifically, using a sample of 124 unique equity REITS with both active short selling and option markets over the past 10 years, we find that when short selling is riskier, option volume is more predictive of future returns. These results suggest that investors view options as an alternative to shorting, and their decision to transact in the derivatives market is materially influenced by short‐selling risk.

Jumping hedges on the strength of the Mellin transform

With more looming uncertainties in our present financial climate and environment, models with jump–diffusion more than ever are necessary. They are suited to reproduce the large and sudden fluctuations in the level of the underlying variable, and mimic various statistical properties in observed time series. The jump–diffusion modelling setup, however, brings complexity to the valuation and hedging of derivative securities. This paper delves into the subject of hedging along with the illustration of hedging’s intimate interplay with pricing. We harness the power of the Mellin transform and its convolution property to establish hedging sensitivities that capture the many dimensions of risk in option positions. Our methodology allows for a wide class of generalised payoffs (i.e. all piecewise linear functions). Each hedging parameter is shown to contain the impact of jumps and an explicit metric to quantify the jump risk is defined. The systematic and efficient calculations of higher-order sensitivities are demonstrated and their implications, from a practical perspective, are also considered. Inclusion of some numerical examples illustrates the ease of implementation of our results.