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One may contend that there are some clear similarities between the market for sustainable assets now and the situation of tech stocks right before the collapse of the dot-com bubble. In fact, before 2000, the risk of the new technology was primarily idiosyncratic because of the limited scale of production and the low likelihood of a widespread adoption. Subsequently, with an increasing probability of adoption, also, the old economy was affected by the new technology and, hence, the wealth of the representative agent. As a result, systematic risk increased, which depressed stock prices, because it pushed up the discount rates in the new and old economies. Similarly, given the high probability of a large-scale adoption of the new “green technology,” it is likely that there is not only a bubble forming in green energy stocks, but the boom is affecting the stock market as a whole. I apply a recently developed recursive testing procedure and dating algorithm that is useful in detecting multiple bubble events. Using S&P 500 stock market data, price-dividend ratios, I identify the well-known historical speculative bubbles and find an explosive movement in today’s market starting in June 2021, which can be associated with the new “green technology.” I find that an explosive movement in green stocks started roughly a year before it was migrating to the whole stock market. I argue that this is a good bubble because it will enable businesses to invest cheaply in green energy, hastening the transition away from fossil fuels and assisting in the fight against climate change.

Using an equilibrium asset and option pricing model in a production economy under jump diffusion, we derive an analytical link between the equity premium, risk aversion and the systematic variance and skewness risk premium. In an empirical application of the model using more than 20 years of data on S&P500 index options, we find that, in line with theory, risk-averse investors demand risk-compensation for holding equity when the systematic skewness risk premium is high. However, when we differentiate between market conditions proxied by investor sentiment, we find that in up-markets (high sentiment) risk aversion is low, while in down-markets (low sentiment) risk aversion is high. We show that in line with theory, the skewness-risk-premium-return relationship only holds when risk aversion is high. In periods of low risk aversion, investors demand lower risk compensation, thus substantially weakening the skewness-risk premium-return trade off. Therefore, we also provide new evidence that helps to disentangle sentiment from risk aversion.

Recently, Christoffersen et al. (Rev Financ Stud 26(8):1963–2006, 2013) argue that the overreaction puzzle of Stein (J Finance 44(4):1011–1023, 1989) can be explained by a variance-dependent pricing kernel. In this note, we challenge this view. Our theoretical results are in line with their argument that the variance under risk-neutral measure is more persistent than the variance under physical measure due to a negative variance risk premium. But our results do not support their argument that the more persistent variance is able to qualitatively explain Stein’s findings. We show theoretically that the persistence of the volatility cannot amplify the movements of long-term variance to short-term fluctuations in variance and, therefore, conclude that Stein’s overreaction puzzle is still unsolved.

The objective of this article is to evaluate the performance of the option pricing model at the cross-sectional level. For that purpose, the authors propose a statistical framework, in which they in particular account for the uncertainty associated with the reported pricing performance. Instead of a single figure, the authors determine an entire probability distribution function for the loss function that is used to measure the performance of the option pricing model. This method enables them to visualize the effect of parameter uncertainty on the reported pricing performance. Using a data-driven approach, the authors confirm previous evidence that standard volatility models with clustering and leverage effects are sufficient for the option pricing purpose. In addition, they demonstrate that there is short-term persistence but long-term heterogeneity in cross-sectional option pricing information. This finding has two important implications. First, it justifies the practitioner’s routine to refrain from time series approaches and instead estimate option pricing models on a cross section by cross section basis. Second, the long-term heterogeneity in option prices pinpoints the importance of measuring, comparing, and testing the option pricing model for each cross section separately. To the authors’ knowledge no statistical testing framework has previously been applied to a single cross section of option prices. They propose a method that addresses that need. The proposed framework can be applied to a broad set of models and data. In the empirical part of the article, they show by means of example, an application that uses a discrete time volatility model on S&P 500 index options. TOPICS:Options, volatility measures Key Findings • Absolute pricing performance, measured by a loss-function, is an inappropriate criteria to benchmark competing option pricing models at the cross-sectional level. • The long-term heterogeneity in cross-sectional option pricing information and the uncertainty of reported pricing performance calls for the necessity to rely on an entire probability distribution function of the loss function when comparing models performance. • This article proposes a statistical framework, based on a data-driven approach, to compare model performance accounting for model uncertainty applicable to a single cross-section of option prices.

This chapter measures the effect of growth in Islamic Banking assets on economic performance in a sample of 32 developed and developing countries based on data for the period 2000-2017. The findings show that, although Islamic banks are considered small relative to the total size of the financial sector, these are positively correlated with economic growth even after controlling for financial structure, macroeconomic factors and other variables. The outcome is robust across different econometric specifications like pooling OLS, fixed effects, and panel data with over-identified GMM. The results are confirmed on two different indicators of Islamic banking and hold for different periods. Empirical findings confirm theoretical expectations that although Islamic banking still represents a relatively very small share of the financial system, it is growing and generating an economic boost to ensure a stable banking industry.

Previous research suggests that short-sellers correctly anticipate that big moves by one or more mutual funds cause temporary price distortions. By moving in the opposite direction to those trades, short-sellers outsmart mutual funds. This appears to be healthy for the overall market, but mutual funds’ vulnerability substantially reduces their profits. For informed traders, the equity lending market and the options market are substitutes for one another. In this paper, I empirically investigate how big moves of mutual funds affect the cross-section of option prices. Overall, I find strong empirical evidence for directional trading in index options. The flow-induced bearish trading activity of short-sellers is price destabilizing and greatly influences put and call option prices. Firstly, in line with the short-selling channel, inflows into mutual funds mainly impact the pricing of put options. The demand for out-of-the money put options leads to a significant drop in risk-neutral skewness. Secondly, inflows (outflows) affect the risk-neutral volatility negatively (positively); the impact on prices is consistent across put and call options. Thirdly, while the effect on risk-neutral skewness is associated with the unexpected component (based on same-day flows) only, the effect on risk-neutral volatility is associated with the unexpected and the expected component (based on prior days’ trading). Finally, while the negative relationship of inflows on risk-neutral volatility and skewness is consistent over time, the effect of outflows on risk-neutral volatility is not observable in bearish markets.

Previous research has focused on the importance of modeling the multivariate distribution for optimal portfolio allocation and active risk management. However, existing dynamic models are not easily applied to high-dimensional problems due to the curse of dimensionality. In this paper, we extend the framework of the Dynamic Conditional Correlation/Equicorrelation and an extreme value approach into a series of Dynamic Conditional Elliptical Copulas. We investigate risk measures such as Value at Risk (VaR) and Expected Shortfall (ES) for passive portfolios and dynamic optimal portfolios using Mean-Variance and ES criteria for a sample of US stocks over a period of 10 years. Our results suggest that (1) Modeling the marginal distribution is important for dynamic high-dimensional multivariate models. (2) Neglecting the dynamic dependence in the copula causes over-aggressive risk management. (3) The DCC/DECO Gaussian copula and t-copula work very well for both VaR and ES. (4) Grouped t-copulas and t-copulas with dynamic degrees of freedom further match the fat tail. (5) Correctly modeling the dependence structure makes an improvement in portfolio optimization with respect to tail risk. (6) Models driven by multivariate t innovations with exogenously given degrees of freedom provide a flexible and applicable alternative for optimal portfolio risk management.

This paper reviews recent trends in alternative investments and their implications as the background for the Special Issue of the Journal of Empirical Finance on Alternative Investments. The historically low bond yields have brought new challenges to many investors in their search for yield, and led many of them to look outside traditional asset classes. The increased flows to alternative assets are motivated by their good performance and diversification benefits. Dynamic trading strategies used by hedge funds, and their increased presence in the financial markets are likely to have profound effects to financial market dynamics. Similarly, the large flows to commodities markets are likely to intensify the financialization of commodities market and its effects.

In this paper, we conduct skewness term-structure tests to check whether the temporal structure of risk-neutral skewness is consistent with rational expectations. Because risk-neutral skewness is substantially mean reverting, skewness shocks should decay quickly and risk-neutral skewness of more distant option should display the rationally expected smoothing behaviour. Using an equilibrium asset and option-pricing model in a production economy under jump diffusion with stochastic jump intensity, we derive this elasticity analytically. In an empirical application of the model using more than 20 years of data on S&P500 index options, we find that this elasticity turns out to be different than suggested under rational expectations – smaller on the short end (underreaction) and larger on the long end (overreaction) of the ‘skewness curve’.

This paper sets the background for the Special Issue of the Journal of Empirical Finance on the European Sovereign Debt Crisis. It identifies the channel through which risks in the financial industry leaked into the public sector. It discusses the role of the bank rescues in igniting the sovereign ndebt crisis and reviews approaches to detect early warning signals to anticipate the buildup of crises. It concludes with a discussion of potential implications of sovereign distress for financial markets.

Among the many anomalies researchers have uncovered in financial markets is Stein’s finding that implied volatilities (IVs) from long-term options are too sensitive to short-shortrun volatility shocks. Option investors overreact to a spike in implied volatility for nearby contracts, and volatilities rise across the maturity spectrum, in contradiction to the smoothing effect when a mean-reverting time series is averaged over a long period. Lehnert, Lin, and Martelin have found a plausible explanation in the fact that mean-reversion of volatility estimated from stock returns is an empirical estimate, while implied volatilities are risk-neutralized values. They show that risk-neutral mean reversion is much slower than in the empirical process. Moreover, it depends on investors’ risk aversion, so that the “overreaction” effect caused by sluggish reversion toward long-run average volatility should be greatest when investors are most averse to risk. They then demonstrate that the theoretical argument is supported by the data. Long-maturity options show significant overreaction to short-maturity IV changes, but the effect is much stronger during periods of market upset. The options market appears to be more rational than Stein’s results suggest.

In this paper, we empirically investigate the impact of the credit risk of Eurozone member countries on the stability of the Euro. In the absence of a common euro bond, euro-area credit risk is induced though the credit default swaps of the member countries. The stability of the euro is examined by decomposing dollar-euro exchange rate options into the moments of the risk-neutral distribution. We document that during the sovereign debt crisis changes in the creditworthiness of member countries have significant impact on the stability of the euro. In particular, an increase in member countries’ credit risk results in an increase of volatility of the dollar-euro exchange rate along with soaring tail risk induced through the risk-neutral kurtosis. We find that member countries’ credit risk is a major determinant of the euro crash risk as measured by the risk-neutral skewness. We propose a new indicator for currency stability by combining the risk-neutral moments into an aggregated risk measure and show that our results are robust to this change in measure. Noticeable is the fact that during the sovereign debt crisis, the creditworthiness of countries with vulnerable fiscal positions is the main risk-endangering factor of the euro-stability.

We proxy the uncertainty in the stock, oil and gold markets with the variance risk premia, extracted from futures and option contracts traded on each of these asset classes. We observe that an independent increase in the stock, oil or gold markets uncertainty coincides with negative returns for a large portion of stocks. However, only the stock market uncertainty is a systematic priced factor in the entire cross section of stock expected returns. The oil price uncertainty is a sector-specific factor, and due to the industry segmentation of the market, it is only priced within oil-relevant industries. Finally, the gold price uncertainty is an asset-specific factor that is neither priced across nor within industries.

We evaluate and compare the abilities of the implied volatility and historical volatility models to provide accurate Value-at-Risk forecasts. Our empirical tests on the S&P 500, Dow Jones Industrial Average and Nasdaq 100 indices over long time series of more than 20 years of daily data indicate that an implied volatility based Value-at-Risk cannot beat, and tends to be outperformed by, a simple GJR-GARCH based Value-at-Risk. This finding is robust to the use of the likelihood ratio, the dynamic quantile test or a statistical loss function for evaluating the Value-at-Risk performance.The poor performance of the option based Value-at-Risk is due to the volatility risk premium embedded in implied volatilities. We apply both non-parametric and parametric adjustments to correct for the negative price of the volatility risk. However, although this adjustment is effective in reducing the bias, it still does not allow the implied volatility to outperform the historical volatility models.These results are in contrast to the volatility forecasting literature, which favors implied volatilities over the historical volatility model. We show that forecasting the volatility and forecasting a quantile of the return distribution are two different objectives. While the implied volatility is useful for the earlier objective function, it is not for the latter, due to the non-linear and regime changing dynamics of the volatility risk premium. (C) 2017 International Institute of Forecasters. Published by Elsevier B.V. All rights reserved.

Purpose – This paper aims to investigate informational efficiency of stock, options and credit default swap (CDS) markets. Previous research suggests that informed traders prefer equity option and CDS markets over stock markets to exploit their informational advantage. As a result, equity and credit derivative markets contribute more to price discovery compared to stock markets. Design/methodology/approach – In this study, the authors investigate the dynamics behind informed investors’ trading decisions in European stock, options and CDS markets. This allows to identify the predictive explanatory power of the unique information contained in each market with respect to future stock, CDS and option market movements. Findings – A lead-lag relation is found between the CDS market and the other markets, in which changes in CDS spreads are able to consistently forecast changes in stock prices and equity options’ implied volatilities, indicating how the fast-growing CDS market seems to play a special role in the price discovery process. Moreover, in contrast to results of US studies, the stock market is found to forecast changes in the other two markets, suggesting that investors also prefer stock market involvement to exploit their information advantages before moving to CDS and option markets. Interestingly, these patterns have only emerged during the recent financial crisis, while before the crisis, the option market was found to be of major importance in the price discovery process. Originality/value – The authors are the first to study the lead-lag relationship among European stock, option and CDS markets for a large sample period covering the financial crisis.

The collapse of Lehman Brothers in 2008 marked the peak of a financial crisis that is affecting the entire world of finance. This period is characterized by increasing fear of further defaults by corporations (including banks) or even by countries. In reaction, investors began shifting their assets to more stable and secure investments and this resulted in stock market crashes. Various policy interventions were initiated to restore stability. In this article, we analyse the impact of these interventions on stock liquidity, proxied by a new liquidity measure. The interventions, which we consider, are published by the Federal Reserve Bank (FED) in the form of a crisis timeline. Here, they are further combined to the following categories: bank liability guarantees, liquidity and rescue interventions, unconventional monetary policy and other market interventions. The results indicate that the market reacts positively to liquidity and rescue interventions, whereas bank liability guarantees reduced stock liquid...

In this paper, we examine the role of national culture in corporate takeover decisions, by arguing that managerial risk tolerance (a combination of risk aversion and risk perception), at the national level, is a cultural trait and affects the expected net synergies CEOs require. We propose a theoretical framework that links CEO risk tolerance to the expected net synergies. We empirically show that CEOs of firms located in countries with lower levels of risk tolerance, measured by Hofstede’s (1980, 2001) uncertainty avoidance score, require higher premiums on takeovers, and show that uncertainty avoidance plays a greater role in relatively large takeovers. Additional testing reveals that CEOs from high uncertainty avoiding nations engage less in cross-border/cross-industry takeovers, suggesting that uncertainty avoidance captures more the CEO’s risk perception than his/her risk aversion.

As research has begun to focus on the fact of less-than-infinite liquidity in real-world financial markets, evidence has begun to accumulate on price effects caused by large trades. Cash inflows into index-based mutual funds can be large and potentially highly correlated across “herding” investors, resulting in flow-induced price effects on the index stocks. In this article, Lehnert shows that mutual fund inflows, which have been shown to push prices of illiquid stocks too far at first only to be followed by predictable reversals later, also affect index options in the form of negative shocks to risk-neutral skewness. Among the interesting results are that inflows are more powerful than outflows; only the unexpected portion of the flow seems to matter; and the effect is largely limited to short maturity options. The article goes on to consider risk-neutral volatility and kurtosis, finding behavior largely consistent with the fund flow hypothesis.

We identify crucial events during the European sovereign debt crisis and investigate their impact on the euro currency. In particular, we analyze how specific announcements related to vulnerable eurozone member states, European Central Bank (ECB) actions, and credit rating downgrades affect the value and the crash risk of the euro. We proxy the appreciation and depreciation of the euro by its abnormal foreign exchange (FX) rate returns with respect to 35 currencies. The crash risk of the euro is proxied by the conditional skewness of the FX rate return distribution with respect to the same currencies. We find that the market reacts positively to news related to countries under EU/IMF rescue umbrella. We discover that ECB actions on average result in a euro depreciation on the day of the announcement reflecting obvious concerns of market participants, but the effect is partly reversed the day after. Our analysis also shows that sovereign and corporate credit rating downgrades tend to lead to a depreciation of the euro and, more importantly, to an increase of the euro crash risk. Interestingly, we find that specific announcements about Greece on average do not substantially affect the euro exchange rate directly; however, it does have an overall significant effect on the euro crash risk, imposing a substantial risk for the stability of the common currency in the eurozone.

GARCH-type models have been very successful in describing the volatility dynamics of financial return series for short periods of time. However, the time-varying behavior of investors, for example, may cause the structure of volatility to change and the assumption of stationarity is no longer plausible. To deal with this issue, the current paper proposes a conditional volatility model with time-varying coefficients based on a multinomial switching mechanism. By giving more weight to either the persistence or shock term in a GARCH model, conditional on their relative ability to forecast a benchmark volatility measure, the switching reinforces the persistent nature of the GARCH model. The estimation of this benchmark volatility targeting or BVT-GARCH model for Dow 30 stocks indicates that the switching model is able to outperform a number of relevant GARCH setups, both in- and out-of-sample, also without any informational advantages.

Previous research indicates that the US market for inflation-linked bonds is not efficient and that market inefficiencies can be exploited by informed traders who include survey estimations or inflation model forecasts in trades on break-even inflation. Results from this extended research over a time-period in which the TIPS market matured and increased in depth, while the volatility of real yields and inflation increased, confirm that TIPS market inefficiency was not temporary but persisted over the entire time period between 1997 and 2009. Using estimations generated by the Survey of Professional Forecasters or forecasts based on the Kothari and Shanken (2004) inflation model to construct a break-even trading strategy leads to excess returns over a static buy-and-hold strategy. These excess returns remain substantial even after accounting for trading costs. Furthermore, TIPS returns still include a substantial liquidity premium, which increased during the financial crisis.

Summary/Zusammenfassung Mandelbrot and the Smile It is a well-documented empirical fact that index option prices systematically differ from Black-Scholes prices. However, previous research provides inconclusive results whether the observed volatility smile could be explained by a discretetime dynamic model of stock returns with skewed, leptokurtic innovations. The improvements in pricing errors are particularly pronounced for out-of-the money put options, while the models partly underperform a Gaussian alternative for near-the-money options. Motivated by theses empirical evidence, I develop a new GARCH option-pricing model with a more flexible innovation structure. In an application of the model to DAX index options, I test the relative performance of the approach against a standard nested GARCH specification and the well-known practitioners Black-Scholes model. I show that the performance of the truncated Levy GARCH option pricing model is superior to existing approaches. (JEL G12) Mandelbrot und das Lac...

In this paper, we investigate the importance of different loss functions when estimating and evaluating option pricing models. Our analysis shows that it is important to take into account parameter uncertainty, because this leads to uncertainty in the predicted option price. We illustrate the effect on the out-of-sample pricing errors in an application of the ad hoc Black-Scholes model to DAX index options. We confirm the empirical results of Christoffersen and Jacobs (Christoffersen, P., K. Jacobs. 2004. The importance of the loss function in option valuation. J. Financial Econom. 72 291–318) and find strong evidence for their conjecture that the squared pricing error criterion may serve as a general-purpose loss function in option valuation applications. At the same time, we provide a first yardstick to evaluate the adequacy of the loss function. This is accomplished through a data-driven method to deliver not just a point estimate of the root mean squared pricing error, but a distribution.

This paper jointly analyzes traditional and behavioral concepts in a simple experimental setting which allows for the assessment of the relative importance of each factor and their joint behavior. Various hypotheses are tested in three portfolio choice models. Markowitz [Markowitz, H., 1952. Portfolio selection. Journal of Finance 7, 77–92] findings are analyzed and extended by behavioral concepts and socio-demographic variables. Models are expressed as conjoint choice models represented by a multinomial logit model. Data is collected in an experimental setting. We show that the level of the risk-free rate, an individual's risk aversion, market sentiment, self-assessed financial expertise, age and gender are determining factors of portfolio choice.

PurposeThe purpose of this paper is to investigate the impact of individual investor sentiment on the return process and conditional volatility of three main US market indices (Dow Jones Industrial Average, S&P500 and Nasdaq100). Individual investor sentiment is measured by aggregate money flows in and out of domestically oriented US mutual funds.Design/methodology/approachA generalised autoregressive conditional heteroscedasticity (GARCH)‐in‐mean specification is used, where our measure for individual sentiment enters the mean and conditional volatility equation.FindingsFor a sample period of six years (February 1998 until December 2004), we find that sentiment has a significant and asymmetric impact on volatility, increasing it more when sentiment is bearish. Using terminology of De Long et al., we find evidence for the “hold more” effect, which states that when noise traders hold more of the asset, they also see their returns increase, and the “create space” effect, which states that noise traders are rewarded for the additional risk they generate themselves.Originality/valueIn contrast to existing studies using explicit measures of market sentiment on low sampling frequencies, the use of daily mutual flow data offers a unique picture on investors' portfolio rebalancing and trading behavior. We propose an integrated framework that jointly tests for the effects of mutual fund flows on stock return and conditional volatility.

This paper presents a new empirical approach to address the problem of trading time differences between markets in studies of financial contagion. In contrast to end-of-business-day data common to most contagion studies, we employ price observations, which are exactly aligned in time to correct for time-zone and end-of-business-day differences between markets. Additionally, we allow for time lags between price observations in order to test the assumption that the shock is not immediately transmitted from one market to the other. Our analysis of the financial turmoil surrounding the asian crisis reveals that such corrections have an important bearing on the evidence for contagion, independent of the methodology employed. Using a correlation-based test, we find more contagion the faster we assume the shock to be transmitted.

We identify crucial events during the European sovereign debt crisis and investigate their impact on the euro currency. In particular, we analyze how specific announcements related to vulnerable Eurozone member states, European Central Bank (ECB) actions, and credit rating downgrades affect the value and the crash risk of the euro. We proxy the value changes of the euro by its abnormal foreign exchange (FX) rate returns with respect to 35 currencies. The crash risk of the euro is proxied by the conditional skewness of the FX rate return distribution with respect to the same currencies. We find that the market reacts positively to news related to countries under the European and International Monetary Fund (IMF) rescue umbrella. We discover that ECB actions on average result in a euro depreciation on the day of the announcement reflecting obvious concerns of market participants, but the effect is partly corrected the day after. Our analysis also shows that sovereign and corporate credit rating downgrades tend to lead to a depreciation of the euro and, more importantly, to an increase of the euro crash risk. Interestingly, we find that specific announcements about Greece on average do not substantially affect the euro exchange rate directly, however, it does have an overall significant effect on the euro crash risk, imposing a substantial risk for the stability of the common currency in the Eurozone.

Previous studies on the cross-sectional market moments’ risk premia find significantly negative risk premia for the market volatility and the market skewness risks and a positive premium for the market kurtosis risk. However, a significantly negative price of risk for the market skewness and a positive price of risk for the market kurtosis move against the ICAPM intuition. We refer to these counter-intuitive prices of risk as the anomalies in the market moments’ risk premia, and show that these anomalies only exist in low risk-aversion periods. Once investors’ risk-aversion rise, these anomalies vanish. Moreover, we find that Baker and Wurgler’s (2006) index of investor sentiment is strongly negatively affected by the past realizations in investor risk-aversion. Consequently, our empirical results can also be replicated by analyzing periods of high and low sentiment, separately.

Previous research suggests that credit rating announcements by Moody’s are anticipated by participants in the credit default swap market. In particular, it is argued that downgrades and negative outlook reports do not contain significant information, but there seems to be anticipation of both types of ratings announcements. In this paper, we examine credit default swap spread changes conditional on a ratings announcement for European reference entities. For our sample of J.P. Morgan Trak-X Europe companies, we find evidence that downgrades and negative outlooks do contain significant information, but find no evidence that announcements are anticipated by participants in the credit default swap market. Additionally, we find evidence that CDS spreads initially do not fully adjust to the information in positive or stable outlook reports resulting in significant post-announcement day effects.

Barberis and shleifer (2003 barberis, n and shleifer, a. 2003. Style investing. Journal of financial economics, 68: 161–99. [crossref], [web of science ®], , [google scholar]) suggest that us investors classify assets into different styles based on, for example, market capitalization or b/m ratios. They find that prices can deviate substantially from fundamental values as a style's popularity changes over time. In this paper, we discuss implications of this prediction and empirically investigate the profitability of style momentum strategies for the uk stock market. Results suggest that a simple trading rule can generate significant positive returns, but for our sample of ftse 350 stocks those strategies are less profitable and more risky compared to regular momentum strategies.

In this paper we investigate the ability of different models to produce useful VaR-estimates for exchange rate positions. We make a distinction between models that include sophisticated tail properties and models that do not. The former type of models often leads to too extreme VaR-estimates, whereas the latter type underestimates the risk in case of extreme events. Our analysis shows that it is important to take into account parameter uncertainty, since this leads to uncertainty in the reported VaR. We make this uncertainty in the VaR explicit by means of simulation. Our empirical results suggest that more sophisticated tail-modeling approaches come at the cost of more uncertainty about the VaR estimate itself. In the case of the GARCH(1,1) - Student model the average VaR may be adjusted for parameter uncertainty to arrive at levels which are adequate according to out-of-sample tests.

The U.K. was the first industrialized country to issue index-linked government bonds. France has joined this group of issuers recently with two series indexed either to French inflation or to inflation in the euro area. This investigation of the efficiency of these markets tests the information content of inflation forecasts to develop trading strategies speculating on the movement of break-even inflation. The results indicate that the market for the French OATi offers the possibility of excess returns, a result that is fairly consistent regardless of market frictions introduced in the return calculation. These trading strategies are beneficial for practitioners tracking index-linked bond indexes in the particular markets.

Despite empirical research and theoretical validity, there is mixed evidence on whether employee stock options align interests between management and shareholders by turning managers into owners. What used to be a functional tool introduced in the 1950s, has gotten out of hand, as perceived by the press and popular literature. The main catalyst is the accounting treatment stock options receive. This paper provides an overview of the empirical research in the field and discusses the current accounting treatment of employee stock options and impending changes. We conclude by proposing alternative compensation tools.

The record-breaking prices observed in the art market for the last three years have rais the question of whether we are experiencing a speculative bubble. Given the difficulty to determine the fundamental value of artworks, we apply a right-tailed unit root test with forward recursive regressions (SADF test) to detect explosive behaviors directly in the time series of four different art market segments (“Impressionist and Modern”, “Post-war and Contemporary”, “American”, and “Latin American”) for the period from 1970 to 2013. We identify two historical speculative bubbles and find an explosive movement in today’s “Post-war and Contemporary” and “American” fine art market segments.

The record-breaking prices observed in the art market over the last three years raise the question of whether we are experiencing a speculative bubble. Given the difficulty to determine the fundamental value of artworks, we apply a right-tailed unit root test with forward recursive regressions (SADF test) to detect explosive behaviors directly in the time series of four different art market segments (“Impressionist and Modern”, “Post-war and Contemporary”, “American”, and “Latin American”) for the period from 1970 to 2013. We identify two historical speculative bubbles and find an explosive movement in today’s “Post-war and Contemporary” and “American” fine art market segments.

The objective of this paper is to evaluate option pricing performance on the cross sectional level. For this purpose, we propose a statistical framework, in which we in particular account for the uncertainty associated with the reported pricing performance. Instead of a single figure, we determine an entire probability distribution function for the loss function that is used to measure option pricing performance. This methodology enables us to visualize the effect of parameter uncertainty on the reported pricing performance. Using a data driven approach, we confirm previous evidence that standard volatility models with clustering and leverage effects are sufficient for the option pricing purpose. In addition, we demonstrate that there is short-term persistence but long-term heterogeneity in crosssectional option pricing information. This finding has two important implications. First, it justifies the practitioner’s routine to refrain from time series approaches, and instead estimate option pricing models on a cross-section by cross-section basis. Second, the long term heterogeneity in option prices pinpoints the importance of measuring, comparing and testing option pricing model for each cross-section separately. To our knowledge no statistical testing framework has been applied to a single cross-section of option prices before. We propose a methodology that addresses this need. The proposed framework can be applied to a broad set of models and data. In the empirical part of the paper, we show by means of example, an application that uses a discrete time volatility model on S&P 500 European options.

In this paper, we conduct skewness term structure tests to check whether the temporal structure of risk-neutral skewness is consistent with rational expectations. Because risk-neutral skewness is substantially mean reverting, skewness shocks should decay quickly and risk-neutral skewness of more distant option should display the rationally expected smoothing behavior. Using an equilibrium asset and option-pricing model in a production economy under jump diffusion with stochastic jump intensity, we derive this elasticity analytically. In an empirical application of the model using more than 20 years of data on S&P500 index options, we find that this elasticity turns out to be different than suggested under rational expectations - smaller on the short end (undereaction) and larger on the long end (overreaction) of the ‘skewness curve’.

Previous research suggests that investor sentiment has an influence on the market's risk-return trade-off. Noise traders' demand for assets is considered to be risk independent and, as a result, risky assets do not offer a risk premium when demand is high. We show that market risk is only a priced factor of expected fund returns when investor sentiment is low. Furthermore, fund investors seem aware that risk is sometimes not priced. During high sentiment periods, "smart" investors buy safe funds that subsequently outperform and sell risky funds that subsequently underperform. Our results are statistically and economically significant.

Empirical studies have shown that implied volatilities of long-term options react quite strongly to changes in implied volatilities of short-term options and do not display the rationally expected smoothing behavior. Given the observed strong mean-reversion in volatility, those findings have been interpreted as evidence for overreaction in the options market. Focusing on a stochastic variance process in a rational expectation framework, we theoretically show that under normal market conditions the risk-neutral volatility dynamics are substantially more persistent than the physical one. As a result, the empirical observation of a strong reaction of long-term volatility would be consistent with perfectly rational behavior. We additionally show that the degree of persistence depends on investors’ risk aversion. Using daily data on S&P 500 index options, we confirm previous findings for the 2000-2010 period, which is characterized by an overall moderate level of risk aversion. Once we identify periods of high and low risk aversion, in line with the predictions of our theoretical model, empirical results only hold for periods, when investors are highly risk averse. During periods of low risk aversion, results are insignificant. Robustness checks reveal that the results are remarkably stable over the complete term structure. Therefore, we provide strong evidence that the empirical observation is not overreaction, but in line with perfectly rational behavior.