Terms Of Hedging Research Articles

Realized Correlations, Betas and Volatility Spillover in the Commodity Market: What Has Changed?

This paper examines the changes in price and return dynamics that affected the commodity market around the 2007-2008 boom&bust. Relying on data at intra-day frequency and adapting the recently proposed realized Beta GARCH model of Hansen et. al (J. Appl. Econ.(2014)), it is shown that starting from 2006 realized correlations between agricultural commodities belonging to the same group and between agriculturals and oil have significantly increased. The rise in correlations between grains - or soft commodities - and oil is especially notable. The dynamics of the volatility spillover across commodities are also investigated. It is found that spillover effects became more evident prior to the commodity price crash. However, this increase in volatility transmission tented to anticipate the increase in correlations. To conclude, it is shown that the optimal ratio of a short position on oil required to hedge a 1$ long position in an agricultural commodity, which corresponds to the the model realized beta, also increased significantly after 2006. This finding has important implication in terms of portfolio hedging and risk management.

Pathwise versions of the Burkholder–Davis–Gundy inequality

We present a new proof of the Burkholder-Davis-Gundy inequalities for $1\leq p<\infty$. The novelty of our method is that these martingale inequalities are obtained as consequences of elementary deterministic counterparts. The latter have a natural interpretation in terms of robust hedging.

Optimal Liquidity management and Hedging in the presence of a non-predictable investment opportunity

In this paper, we develop a dynamic model that captures the interaction between a firm’s cash reserves, the risk management policy and the profitability of a non-predictable irreversible investment opportunity. We consider a firm that has assets in place generating a stochastic cash-flow stream. The firm has a non-predictable growth opportunity to expand its operation size by paying a sunk cost. When the opportunity is available, the firm can finance it either by cash or by costly equity issuance. We provide an explicit characterization of the firm strategy in terms of investment, hedging, equity issuance and dividend distribution.

A trajectorial interpretation of Doob’s martingale inequalities

We present a unified approach to Doob’s $L^{p}$ maximal inequalities for $1\leq p<\infty$. The novelty of our method is that these martingale inequalities are obtained as consequences of elementary deterministic counterparts. The latter have a natural interpretation in terms of robust hedging. Moreover, our deterministic inequalities lead to new versions of Doob’s maximal inequalities. These are best possible in the sense that equality is attained by properly chosen martingales.

Model-independent bounds for option prices—a mass transport approach

In this paper we investigate model-independent bounds for exotic options written on a risky asset using infinite-dimensional linear programming methods. Based on arguments from the theory of Monge–Kantorovich mass transport, we establish a dual version of the problem that has a natural financial interpretation in terms of semi-static hedging. In particular we prove that there is no duality gap.

Operational risks

Steady progress of the financial and banking sector caused complex business problems. One of these problems are expressed through a number of risks that banks face in their daily operations. These banks were able to maintain their liquidity and generate strategic aim, it is relevant to implement a series of measures and techniques in terms of hedging. These risks may be numerous, whether they are caused by human factor, information technology, or even a certain market movements. Today the great focus is based on banking risks. Operational risk is a particular form of banking risk. This risk exists not only in an economic but also in a non-economic sector. As the operational risk has a constant development tendency and takes new forms, it is still very popular topic. It is one of the reasons why this risk is reviewed within this paper.

Model-Independent Bounds for Option Prices: A Mass Transport Approach

In this paper we investigate model-independent bounds for exotic options written on a risky asset using infinite-dimensional linear programming methods. Using arguments from the theory of Monge-Kantorovich mass-transport we establish a dual version of the problem that has a natural financial interpretation in terms of semi-static hedging.

Generalized parameter functions for option pricing

We extend the benchmark nonlinear deterministic volatility regression functions of Dumas et al. (1998) to provide a semi-parametric method where an enhancement of the implied parameter values is used in the parametric option pricing models. Besides volatility, skewness and kurtosis of the asset return distribution can also be enhanced. Empirical results, using closing prices of the S&P 500 index call options (in one day ahead out-of-sample pricing tests), strongly support our method that compares favorably with a model that admits stochastic volatility and random jumps. Moreover, it is found to be superior in various robustness tests. Our semi-parametric approach is an effective remedy to the curse of dimensionality presented in nonparametric estimation and its main advantage is that it delivers theoretically consistent option prices and hedging parameters. The economic significance of the approach is tested in terms of hedging, where the evaluation and estimation loss functions are aligned.

Efficient Portfolios When Housing Needs Change Over the Life-Cycle

We address the issue of the efficiency of household portfolios in the presence of housing risk. We treat housing stock as an asset and rents as a stochastic liability stream: over the life-cycle, households can be short or long in their net housing position. Efficient financial portfolios are the sum of a standard Markowitz portfolio and a housing risk hedge term that multiplies net housing wealth. Our empirical results show that net housing plays a key role in determining which household portfolios are inefficient. The largest proportion of inefficient portfolios obtains among those with positive net housing, who should invest more in stocks.

Efficient portfolios when housing needs change over the life cycle

We address the issue of the efficiency of household portfolios in the presence of housing risk. We treat housing stock as an asset and rents as a stochastic liability stream: over the life cycle, households can be short or long in their net-housing position. Efficient financial portfolios are the sum of a standard Markowitz portfolio and a housing risk hedge term that multiplies net housing wealth. Our empirical results show that net housing plays a key role in determining which household portfolios are inefficient. The largest proportion of inefficient portfolios obtains among those with positive net housing, who should invest more in stocks.

Are Household Portfolios Efficient? An Analysis Conditional on Housing

Standard tests of portfolio efficiency neglect the existence of illiquid wealth. The most important illiquid asset in household portfolios is housing: if housing stock adjustments are infrequent, optimal portfolios in periods of no adjustment are affected by housing price risk through a hedge term and tests for portfolio efficiency of financial assets must be run conditionally upon housing wealth. We use Italian household portfolio data and time series on financial assets and housing stock returns to assess whether actual portfolios are efficient. We find that housing wealth plays a key role in determining whether portfolios chosen by home-owners are efficient.

Development of Reality-Status Semantics in Early Childhood

The distinction between reality and various forms of non-reality, i.e. apparent, imaginary, counterfactual or fictional objects or events, is central to many domains of cognition (Flavell, 1988; Clark, 1996; Harris, 2000; Gelman, 2003). Reality is an abstract and broadly applicable concept; for instance, the word real is used to express different types of information in statements like Unicorns are real, This is a real diamond and The patient's life is in real danger. Despite its semantic complexity, this domain is invoked by children's language early in development. By three years of age children use such expressions as real/really, pretend/make-believe, looks/sounds/is like to distinguish reality from non-reality (Woolley & Wellman, 1990; Woolley, 2002), though their construal of these terms' meaning may not be adult-like (Lillard 2001; Hansen & Markman, 2005). Despite long-standing interest in children's developing conception of reality vs. non-reality, their use and comprehension of the relevant vocabulary have not been directly addressed. The present study examines spontaneous use of common reality-status terms by young children and their parents in everyday conversation. Our main hypothesis, drawing on the cognitive-semantics analysis of polisemy (Lakoff, 1987) and on the conceptualchange account of cognitive development (Carey, 1988), is that children's conceptualization of reality and non-reality undergoes progressive elaboration and differentiation, which is reflected in their use of reality-status vocabulary. We present a semantic analysis of reality-status terms and posit predicate modification as these terms' common function. For instance, by saying This is like an orange or This is a real orange speakers convey information about the strength and scope of the current application of the predicate is an orange, analogous to the information conveyed by hedge terms (e.g. John is somewhat/definitely/extremely tall; see Lakoff, 1972). From this analysis we derive empirical predictions about the developmental trajectory of young children's use of reality-status vocabulary, including the order in which different words and different word senses enter children's lexicon. We predict that children should initially use reality-status expressions as simple intensifiers/detensifiers and subsequently express more specific information about the nature of modification, e.g. fiction vs. reality, apparent vs. actual kind membership, reality vs. representation of reality, etc. Our predictions are then tested against a longitudinal corpus of spontaneous parent-child conversations, obtained from 64 families. Despite considerable variation in how early and how often children produce reality-status terms, these data reveal a common pattern in line with our predictions. We find furthermore, that while the frequency of parental use of reality-status terms predicts the overall timing of children's acquisition, it can not account for the order in which different senses of these terms are expressed in children's speech. We argue that these findings support our semantic analysis of reality status. Taken as a case study of children's acquisition of abstract vocabulary, our findings suggest that it involves stepwise structuring and augmentation of conceptual frameworks by children using input from adults as evidence. At the same time, our study exemplifies the potential utility of child language data as empirical evidence on semantic analysis of polisemy.

Are Household Portfolios Efficient? an Analysis Conditional on Housing

AbstractStandard tests of portfolio efficiency neglect the existence of illiquid wealth. The most important illiquid asset in household portfolios is housing: if housing stock adjustments are infrequent, optimal portfolios in periods of no adjustment are affected by housing price risk through a hedge term and tests for portfolio efficiency of financial assets must be run conditionally upon housing wealth. We use Italian household portfolio data and time series on financial assets and housing stock returns to assess whether actual portfolios are efficient. We find that housing wealth plays a key role in determining whether portfolios chosen by homeowners are efficient.

Endowment Assurance Products: Effectiveness of Risk-Minimizing Strategies under Model Risk

This paper analyzes and discusses the effects of model misspecification associated with both interest rate and mortality risk on the hedging decisions of insurance companies. We consider hedging strategies in different instruments (zero bonds) which are risk- (variance-) minimizing with respect to an assumed model. In this case, the associated expected costs and the variance of the costs are the same for all strategies. While the introduction of model risk, i.e. a deviation of assumed from true models, has the same effect on the expected costs, this is not true with respect to the variance. It turns out that the choice of hedging instruments has a crucial impact on the robustness of the strategies. In addition, the results of the paper can be used to emphasize the necessity to use a combined hedging model. In terms of robust hedging, a separate specification of interest rate model and mortality model is inconvenient, even in the case that interest rate and mortality are assumed to be independent.

Endowment Assurance Products: Effectiveness of Risk-Minimizing Strategies under Model Risk

This paper analyzes and discusses the effects of model misspecification associated with both interest rate and mortality risk on the hedging decisions of insurance companies. We consider hedging strategies in different instruments (zero bonds) which are risk- (variance-) minimizing with respect to an assumed model. In this case, the associated expected costs and the variance of the costs are the same for all strategies. While the introduction of model risk, i.e. a deviation of assumed from true models, has the same effect on the expected costs, this is not true with respect to the variance. It turns out that the choice of hedging instruments has a crucial impact on the robustness of the strategies. In addition, the results of the paper can be used to emphasize the necessity to use a combined hedging model. In terms of robust hedging, a separate specification of interest rate model and mortality model is inconvenient, even in the case that interest rate and mortality are assumed to be independent.

Does conditional market skewness resolve the puzzling market risk-return relationship?

In this paper, we employ instrumental variables methods that allow time-varying risk and reward-to-risk to test various conditional asset pricing models. We find a negative partial relation between the market excess return and conditional market variance. In contrast with recent findings, we show that this negative relationship is not due to the omission of the hedge term associated with the ICAPM. However, conditional market skewness seems to partly account for this negative risk-return relationship.

Exchange rates and stock prices interaction during good and bad times: evidence from the ASEAN4 countries

Using bootstrap causality tests with leveraged adjustments, the link between exchange rates and stock prices in Malaysia, Indonesia, Philippines and Thailand is investigated for the periods immediately before and during the 1997 Asian crisis. Two variables are found to be significantly linked in the non-crisis period but not at all during the crisis period. The implications of this result in terms of hedging, market efficiency, market integration and policy intervention are explained in the paper.

Efficient Portfolios when Housing is a Hedge Against Rent Risk

In this paper we address the issue of the efficiency of household portfolios in the presence of housing risk. We present a theoretical model in which housing needs are age-dependent but exogenously determined, and consumers choose whether to rent or own the corresponding housing stock. Consumers also decide their consumption of a non-durable good and their financial investment strategies. They can invest in a risk-less asset (that includes human capital) and n risky financial assets. If the rental value of housing has a positive correlation with house prices, owning is a hedge against rent risk. When this correlation is unitary, we show that efficient financial portfolios should be the sum of a standard Markowitz portfolio and of a hedge term. This hedge term is a function of the correlations between housing and financial assets returns and multiplies the difference between the value of the housing stock owned and the present value of current and future housing needs. In our application we use Italian household portfolio data and time series data on financial assets and housing stock returns. Our empirical results support the view that the presence of housing risk plays a key role in determining whether household portfolios are efficient. They also highlight the need to distinguish between households who are long on housing (homeowners whose housing needs are declining) or short on housing (tenants and homeowners whose housing needs are still increasing).

Pricing and hedging S&amp;P 500 index options with Hermite polynomial approximation: empirical tests of Madan and Milne's model

The universal use of the Black and Scholes option pricing model to value a wide range of option contracts partly accounts for the almost systematic use of Gaussian distributions in finance. Empirical studies, however, suggest that there is an information content beyond the second moment of the distribution that must be taken into consideration.This article applies a Hermite polynomial‐based model developed by Madan and Milne (1994) to an investigation of S&P 500 index option prices from the CBOE when the distribution of the underlying index is unknown. The model enables us to incorporate the non‐normal skewness and kurtosis effects empirically observed in option‐implied distributions of index returns. Out‐of‐sample tests confirm that the model outperforms Black and Scholes in terms of pricing and hedging. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 735–758, 1999

How important is the correlation between returns and volatility in a stochastic volatility model? Empirical evidence from pricing and hedging in the S&amp;P 500 index options market

Abstract This paper examines the importance of allowing for correlation between returns and volatility in a continuous time stochastic volatility option pricing model. Specifically it tests the closed-form stochastic volatility model of Heston (Review of Financial Studies 6, 1993, 327–343) that allows for non-zero correlation, in terms of pricing and hedging options on the S&P 500 index. It is found that non-zero correlation in the stochastic volatility model leads to significant improvements in mispricing of out-of-the-money options and overall pricing performance compared to if correlation is constrained to be zero. In terms of hedging, non-zero correlation results in significantly lower hedging errors for out-of-the-money options.