Derivative Securities Research Articles

Esposito's temporality of finance: Endogeneity and revisability in derivative transactions

AbstractRecent years have seen greater interest in the theoretical foundations of abstract finance and their intersection with questions of philosophy and sociology. In particular, exchanges between authors such as Donald MacKenzie, Timothy Johnson, Elie Ayache, and others have debated the deterministic or contingent dynamics of markets, as well as their interdependency with the theories that purport to describe them. Working in this tradition, Elena Esposito raises a novel question in her 2011 book, The Future of Futures: could the exchange of derivative securities within financial markets entail not so much the provision of liquidity, but the transaction of time? In this article, I reconstruct Esposito's analysis, arguing that the proper response to this question should be affirmative. Particular emphasis is laid on what I take to be the two fundamental and controversial premises which support this argument: first, the endogeneity of time-relations involved in financial markets; and second, the revisability of these time- relations. The advantage of recasting Esposito's position in this way is the defence it enables against various criticisms articulated in theory and philosophy circles, such as those of Ray Brassier. Finally, I discuss the significance of Esposito's theory, not only for this class of financial transactions, but also for certain issues in the philosophy of time.

ДЕРИВАТИВИ ЯК ФІНАНСОВІ ІННОВАЦІЇ ФІКТИВНОГО КАПІТАЛУ

The article considers the economic nature of derivatives as financial innovations of fictitious capital. Their essence and various classification forms are characterized. It is determined that derivatives are used mainly for risk hedging, as well as for the implementation of investment strategy. Derivatives as innovative financial products are formed as a result of specific relations of economic entities in the process of their innovative activity in the financial market. These relationships allow to meet the needs associated with the search for sources of funding, involve virtually unlimited opportunities for variation in the amount of risk and its redistribution, provide liquidity and increase the final financial results. By setting future prices, participants in futures contracts can plan their activities in the future. Prices in this market are a kind of indicator of the future state of the economy. The development of the derivatives market in Ukraine is slow, and is accompanied by low trading volumes and a rather limited range of derivative securities used as a hedging instrument, so it is important to study global trends in its operation at the present stage. In the context of financial globalization, derivatives are an integral part of global capital markets, and derivatives help a wide range of end users to manage risk and improve profits. Participants in the global derivatives market say that their liquidity remains unchanged or improves in 2019, with more than 80% expecting the same in 2020. Such positive sentiment from end consumers, investors, clearing companies, brokers, traders and exchanges, participating in global derivatives markets is an indicator of high confidence. The analysis of the functioning of the world derivatives market and the development of the derivatives market in Ukraine is carried out. Positive and negative tendencies of development of this market are revealed. The main problematic aspects that hinder the effective operation of the domestic derivatives market are outlined. Based on the analysis of the state and dynamics of the derivatives market in Ukraine, the main directions of its development are proposed.

DIALECTICS OF THE ECONOMIC ESSENCE OF DERIVATIVES

The economic essence of derivatives has been clarified for the correct classification of their types, determination of components and mechanism of action of the derivatives market, development of basic concepts of derivatives pricing by the realities of the Ukrainian economy. The views of the leading scientists of the world on derivatives determination are investigated. The incorrectness of the term urgent derivatives concept has been proved since the economic nature of derivatives already implies urgency. The objection to the definition of a derivative as a “standard-form financial instrument belonging to the category of “derivative securities” (or second-tier securities) confirming the right or obligation of its owner to buy or sell securities, currency, commodities or intangible assets is justified, on predefined terms, in the future”. It is determined, first, that derivatives may have a non-standard form, in particular over-the-counter (OTC) derivatives; secondly, they do not belong to derivatives, since the latter are lower-tier counterfeit titles compared to derivatives; third, it is unclear what is the meaning of the category “second-tier securities”, since it is not specified what is the second-tier. It is proved that the definition of derivatives due to the peculiarities of their market mechanism, pricing, structural elements is not fully determined since the features should be substantive, and not vice versa – to determine the object. The results of the study of the dialectics of the economic nature of derivatives have shown that the terms “derivative”, “fixed-term financial instrument”, “derivative securities”, “fixed-term contract” are used as synonyms. It is substantiated that the use of different definitions leads to contradictions of general economic, legal and organizational nature, which slows down and distorts the development of the derivatives market of Ukraine. The conciseness and content of the definition of the following types of derivatives are substantiated: forward contracts, futures contracts, options contracts, contract swaps. It is proposed to identify the main types of “financial derivatives”. The feasibility of considering derivatives in two aspects has been proved. In the narrow sense, these are fixed-term contracts (forwards, futures, options, and swaps) and the specific terms of their conclusion and performance. In a broad sense, derivatives cover all types of fixed-term contracts, secondary securities, as well as products of modern financial engineering technologies, including structured, hybrid, synthetic financial instruments. Key words: derivative, fixed-term contract, security, financial instrument.

The term structure of volatility predictability

Volatility forecasting is crucial for portfolio management, risk management, and pricing of derivative securities. Still, little is known about the accuracy of volatility forecasts and the horizon of volatility predictability. This paper aims to fill these gaps in the literature. We begin this paper by introducing the notions of spot and forward predicted volatilities and propose describing the term structure of volatility predictability by spot and forward forecast accuracy curves. Then, we perform a comprehensive study of the term structure of volatility predictability in stock and foreign exchange markets. Our results quantify the volatility forecast accuracy across horizons in two major markets and suggest that the horizon of volatility predictability is significantly longer than that reported in earlier studies. Nevertheless, the aforesaid horizon is observed to be much shorter than the longest maturity of traded derivative contracts.

Speculation Sentiment - Executive Summary

I exploit a novel setting to measure disagreement between unsophisticated speculators and smart money, that is, the leveraged exchanged-traded funds' (ETFs) primary market. The leveraged ETFs' primary market provides observable arbitrage activity that originates from unobservable speculative demand shocks that create relative mispricing between a leveraged ETF and its underlying derivative securities. I form the Speculation Sentiment Index using the realized arbitrage trades and the index proxies for the direction and magnitude of market-wide speculative demand shocks. The Speculation Sentiment Index predicts aggregate asset returns, anomaly returns, and it is associated with market-wide mispricing and arbitrage activity.

Optimal investment with derivatives and pricing in an incomplete market

This paper investigates the optimal investment strategy and the pricing of derivatives in an incomplete financial market with one risk-free asset, one stock and one non-redundant derivative security. In the exponential utility maximization criterion, a dynamic relationship between optimal positions for the stock and derivative security is established and the dynamic derivatives pricing formulae depending on the current optimal positions are also obtained by employing the stochastic control approach. The explicit representations of the corresponding solutions are demonstrated and their properties are discussed. Finally, numerical results are presented to characterize the behavior of the derivative security price.

A martingale approach for asset allocation with derivative security and hidden economic risk

AbstractAsset allocation with a derivative security is studied in a hidden, Markovian regime-switching, economy using filtering theory and the martingale approach. A generalized delta-hedged ratio and a generalized elasticity of an option are introduced to accommodate the presence of the information state process and the derivative security. Malliavin calculus is applied to derive a solution for a general utility function which includes an exponential utility, a power utility, and a logarithmic utility. A compact solution is obtained for a logarithmic utility. Some economic implications of the solutions are discussed.

Entropic Dynamics of Stocks and European Options.

We develop an entropic framework to model the dynamics of stocks and European Options. Entropic inference is an inductive inference framework equipped with proper tools to handle situations where incomplete information is available. The objective of the paper is to lay down an alternative framework for modeling dynamics. An important information about the dynamics of a stock’s price is scale invariance. By imposing the scale invariant symmetry, we arrive at choosing the logarithm of the stock’s price as the proper variable to model. The dynamics of stock log price is derived using two pieces of information, the continuity of motion and the directionality constraint. The resulting model is the same as the Geometric Brownian Motion, GBM, of the stock price which is manifestly scale invariant. Furthermore, we come up with the dynamics of probability density function, which is a Fokker–Planck equation. Next, we extend the model to value the European Options on a stock. Derivative securities ought to be prices such that there is no arbitrage. To ensure the no-arbitrage pricing, we derive the risk-neutral measure by incorporating the risk-neutral information. Consequently, the Black–Scholes model and the Black–Scholes-Merton differential equation are derived.

CONCEPT AND CLASSIFICATION OF DERIVATIVE FINANCIAL INSTRUMENTS AS A METHODOLOGICAL PRECISION ON THEIR REGULATION IN THE FINANCIAL SERVICES MARKET

The urgency of the research topic is caused by the rapid growth of capital markets and the emergence of all new financial instruments, the complexity of their structure and the transition beyond the regulatory influence of supervisory authorities. Discussion issues on the identification of derivatives, as well as their certain types, create significant problems with their valuation, the correctness of accounting, and the application of regulatory measures. Inconsistency in the interpretation of derivative financial instruments nature and their certain types is also present in domestic legal acts. Therefore, until the elimination of these shortcomings, derivative financial instruments create additional risks for their owners – financial institutions, as well as for creditors and depositors. The purpose of the research, conducted in the article, lies in the clarification of derivatives nature and developing an appropriate classification of their types in order to its further use with a view of regulation. The methodological basis of the research. The methodological basis of the study is a dialectical approach to the understanding of the essence of derivative financial instruments; general scientific methods of knowledge of phenomena and processes (monographic, abstract-logical, synthesis, comparison, generalization), analysis of legal acts in the part of treatment of derivatives, derivative financial instruments and derivative securities, methods of grouping systematization and generalization in developing the classification of derivative financial instruments. Scientific results. It has been established that in order to maintain the stability of financial markets and their participants, the transformation of regulatory measures should be a permanent development and modification of the financial instruments that are being rotated. Various approaches to the interpretation of derivative financial instruments essence in normative legal acts and scientific literature have been analysed in order to improve the regulation of their issuance and circulation. This made it possible to streamline the conceptual apparatus and to group certain types of derivatives according to certain classification grounds. The basis for classification is the concept of “derivative financial instruments” as the broadest, which includes derivative securities and term contracts (derivatives). The concept of derivatives and derivative securities are delimited based on the study of terminology. It was established that derivatives are standard documents that certify the right and/or obligation to purchase or sell future securities, tangible or intangible assets, as well as funds or make payments on terms and conditions specified by them. However, in some cases, derivatives may acquire features of derivative securities, in particular, when issued through emission and freely traded in markets and bring income (losses) to their owner as a result of changes in their market value. The practical significance. The practical value of the research is the possibility of using the developed classification for the needs of emission regulation and the circulation of derivative financial instruments.

Pointwise Arbitrage Pricing Theory in Discrete Time

We develop a robust framework for pricing and hedging of derivative securities in discrete-time financial markets. We consider markets with both dynamically and statically traded assets and make minimal measurability assumptions. We obtain abstract (pointwise) fundamental theorem of asset pricing and pricing–hedging duality. Our results are general and, in particular, cover both the so-called model independent case as well as the classical probabilistic case of Dalang–Morton–Willinger. Our analysis is scenario-based: a model specification is equivalent to a choice of scenarios to be considered. The choice can vary between all scenarios and the set of scenarios charged by a given probability measure. In this way, our framework interpolates between a model with universally acceptable broad assumptions and a model based on a specific probabilistic view of future asset dynamics.

A Closer Look at the Disposition Effect in U.S. Equity Option Markets

The authors explore whether the disposition effect occurs in U.S. equity option markets. The disposition effect implies past winning securities will be undervalued and past losing securities will be overvalued. By adapting Grinblatt and Han’s unrealized capital gains proxy to the option markets, the authors document a significant relationship between option capital gains overhang and option returns. They also find open interest decreases as option capital gains overhang increases, consistent with a disposition effect in U.S. equity options. This evidence contributes to the emerging literature on behavioral finance in derivative securities.

Forward-looking information on growth and uncertainty implied by derivative securities: Evidence from an emerging market

In this paper, we investigate investors' expectations on economic growth and uncertainty risk implied by derivative securities. Empirical evidence on investors’ expectations implied by derivative securities has been intensively studied in the U.S. and other developed markets, however, such evidence still seems to be rare for emerging markets. Using high frequency data of the Taiwan Stock Exchange (TAIEX) weighted index and its derivatives from Jan-02-2003 to Dec-31-2014, we construct time series of implied dividends, variance risk premium and higher risk-neutral moments. We find that term structure of the implied dividend yield and variance risk premium have some abilities on predicting the excess return of the TAIEX weighted index and growth of industrial production index of Taiwan. We also demonstrate that there is a strong and positive relation between the risk-neutral skewness and options slope, which is in line with what previous literature found in the U.S. stock market.

The Term Structure of Volatility Predictability

Volatility forecasting is crucial for portfolio management, risk management, and pricing of derivative securities. Still, little is known about the accuracy of volatility forecasts and the horizon of volatility predictability. This paper aims to fill these gaps in the literature. We begin this paper by introducing the notions of the spot and forward predicted volatilities and propose to describe the term structure of volatility predictability by the spot and forward forecast accuracy curves. Then we perform a comprehensive study on the term structure of volatility predictability in the stock and foreign exchange markets. Our results quantify the volatility forecast accuracy across horizons in the two major markets and suggest that the horizon of volatility predictability is significantly longer than that reported in the earlier studies. Nevertheless, the horizon of volatility predictability is found to be much shorter than the longest maturity of traded derivative contracts.

Valuation of European Call Options Using Wavelet-Based Pricing Model and Black-Scholes Pricing Model

The Black- Scholes model is a well-known model for hedging and pricing derivative securities. However, it exhibits some systematic biases or unrealistic assumptions like the log-normality of asset returns and constant volatility. A number of studies have attempted to reduce these biases in different ways. The objective of this study is to value a European call option using a non-parametric model and a parametric model. Amongst the non-parametric approaches used to improve the accuracy of the model in this study is the Wavelet-based pricing model. This model is found as promising alternative as far as pricing of European options is concerned, due to its varied volatility of the underlying security and estimation of the risk neutral MGF. This study made an attempt to improve the accuracy of option price estimation using Wavelet method and it improves the accuracy due to its ability to estimate the risk neutral MGF. The MSE and RMSE of Wavelet model is 0.208546 and 0.456669 respectively which is much lower than that of Black-Scholes model and therefore in conclusion, Wavelet model outperforms the other model. The study was carried out using simulated stock prices of 1024 observations.

Institucionalni i regulatorni aspekti primene finansijskih instrumenata za upravljanje rizikom u Republici Srbiji

This paper presents an analysis of institutional and regulatory framework for the implementation of a new group of financial instruments for risk management purposes that should enable faster economic development of the Republic of Serbia. The development of a country's economy is measured, among other things, in terms of the degree of development of its financial market, which consists of several segments. One of them is the trade of derivative securities. American authors point out that the economies of developing countries with more developed financial markets show better results and more stable economic growth compared to those which do not have or have neglected the development of financial markets and instruments. Investors are interested in hedging (securing) their investments, i.e. with the purpose of reducing or eliminating financial and business risks. The development and application of exotic options as modern financial instruments for risk management purposes is an important requirement for attracting foreign investments, as well as for increasing domestic investments, as it offers the possibility of reducing or eliminating risks that deter investors. In the Republic of Serbia, there is a regulatory and institutional framework for trade in all types of financial derivatives, including exotic options as well. Bearing in mind that the financial market in the Republic of Serbia is becoming a part of the global financial market, exotic options are one of the instruments for integrating our economy into global economic flows. However, the domestic financial market lacks financial derivative instruments that would give an additional impetus to its development and trade.

The Impact of FuturesContracts On Risk and Returns of the VN30 Index in Vietnam

In this paper, we analyze the effects of derivatives of the Vietnam Ho Chi Minh (VN) Stock Index and VN30 futures contract for the underlying stock markets. We use the data taken from daily transactions in the market so that the research results will be more objective and more accurate. Specifically, we apply the Exponential Generalized Autoregressive Conditional Heteroscedastic (EGARCH) model to analyze the data. The results illustrate that the occurrence of leverage effects in the profitability of VN30 and VN stock indexes and the liquidity of futures contract transactions have increased over time. The main contribution of this paper is that it is possible to predict the growth trend of derivative securities to make appropriate recommendations for investors. However, the evidence still has some limitations since it only assesses the impact of futures contracts during the specific time, which is the period of instruments that have just appeared.

Modelling volatility of cryptocurrencies using Markov-Switching GARCH models

This paper aims to select the best model or set of models for modelling volatility of the four most popular cryptocurrencies, i.e. Bitcoin, Ethereum, Ripple and Litecoin. More than 1000 GARCH models are fitted to the log returns of the exchange rates of each of these cryptocurrencies to estimate a one-step ahead prediction of Value-at-Risk (VaR) and Expected Shortfall (ES) on a rolling window basis. The best model or superior set of models is then chosen by backtesting VaR and ES as well as using a Model Confidence Set (MCS) procedure for their loss functions. The results imply that using standard GARCH models may yield incorrect VaR and ES predictions, and hence result in ineffective risk-management, portfolio optimisation, pricing of derivative securities etc. These could be improved by using instead the model specifications allowing for asymmetries and regime switching suggested by our analysis, from which both investors and regulators can benefit.

The Limits to Volatility Predictability: Quantifying Forecast Accuracy Across Horizons

Volatility forecasting is crucial for portfolio management, risk management, and pricing of derivative securities. Still, little is known about how far ahead one can forecast volatility. First, in this paper we introduce the notions of the spot and forward predicted volatilities and propose to describe the term structure of volatility predictability by the spot and forward forecast accuracy curves. Then, by employing a few popular time-series volatility models, we perform a comprehensive empirical study on the horizon of volatility predictability. Our results suggest that, whereas the spot volatility can be predicted over horizons that extend to 35 weeks, the horizon of the forward volatility predictability is rather short and limited to approximately 7.5 weeks. Finally, we suggest a plausible explanation for why standard models fail to provide sensible longer-horizon volatility forecasts.

THE IMPACT OF DERIVATIVES ON THE VOLATILITY OF TURKISH STOCK MARKET

The interaction among futures and spot markets has been one of the most important issues of the financial markets since the launch of stock index futures by Kansas City Board of Trade in 1982. The main characteristics of derivatives such as having lower transaction costs, higher leverage, higher liquidity and higher flexibility compared to spot markets make them attractive for investors. Besides, derivatives trading are crucial for financial system participants in order to diversify portfolio and minimise risks. The aim of this paper is to emphasize the importance of derivative securities by providing evidence from an emerging stock market, Turkey. In order to emphasize the need for derivatives in the Turkish market, the impact of introduction of index futures and index options trading on the underlying spot market volatility are empirically analysed. Conditional and unconditional volatility of Borsa Istanbul 30 Index is examined using GARCH model starting from its first trade day of January 2, 1997.

Option Pricing in Illiquid Markets with Jumps

ABSTRACTThe classical linear Black–Scholes model for pricing derivative securities is a popular model in the financial industry. It relies on several restrictive assumptions such as completeness, and frictionless of the market as well as the assumption on the underlying asset price dynamics following a geometric Brownian motion. The main purpose of this paper is to generalize the classical Black–Scholes model for pricing derivative securities by taking into account feedback effects due to an influence of a large trader on the underlying asset price dynamics exhibiting random jumps. The assumption that an investor can trade large amounts of assets without affecting the underlying asset price itself is usually not satisfied, especially in illiquid markets. We generalize the Frey–Stremme nonlinear option pricing model for the case the underlying asset follows a Lévy stochastic process with jumps. We derive and analyze a fully nonlinear parabolic partial-integro differential equation for the price of the option contract. We propose a semi-implicit numerical discretization scheme and perform various numerical experiments showing the influence of a large trader and intensity of jumps on the option price.