Interest Rate (IR). It was found that inflation and interest rate are the two significantly influ... more Interest Rate (IR). It was found that inflation and interest rate are the two significantly influencing macroeconomic factors (p<0.05) on the stock market volatility of emerging Economy of Sri Lanka.
Heteroskedasticity biases tests for contagion based on correlation coefficients. When contagion i... more Heteroskedasticity biases tests for contagion based on correlation coefficients. When contagion is defined as a significant increase in market comovement after a shock to one country, previous work suggests contagion occurred during recent crises. This paper shows that correlation coefficients are conditional on market volatility. Under certain assumptions, it is possible to adjust for this bias. Using this adjustment, there was virtually no increase in unconditional correlation coefficients~i.e., no contagion! during the 1997 Asian crisis, 1994 Mexican devaluation, and 1987 U.S. market crash. There is a high level of market comovement in all periods, however, which we call interdependence.
Realized volatility affords the ex-post empirical measurement of the latent notional volatility. ... more Realized volatility affords the ex-post empirical measurement of the latent notional volatility. However, the time-varying returns autocorrelation induced by microstructure effects represents a challenging problem for standard volatility measures. In this study, a new nonparametric volatility measures approach based on the Discrete Sine Transform (DST) is proposed. We show that the DST exactly diagonalizes the covariance matrix of MA(1) process. This original result provides us an orthonomal basis decomposition of the return process which permits to optimally disentangle the underlying efficient price signal from the time-varying nuisance component contained in tick-by-tick return series. As a result, two nonparametric volatility estimators which fully exploit all the available information contained in high frequency data are constructed. Monte Carlo simulations based on a realistic model for microstructure effects show the superiority of DST estimators, compared to alternative local volatility proxies for every level of the noise to signal ratio and a large class of noise contaminations. These properties make the DST approach a nonparametric method able to cope with time-varying autocorrelation, in a simple and efficient way, providing robust and accurate volatility estimates under a wide set of realistic conditions. Moreover, its computational efficiency makes it well suitable for real-time analysis of high frequency data.
A vast literature on the effects of sterilized intervention by the monetary authorities in the fo... more A vast literature on the effects of sterilized intervention by the monetary authorities in the foreign exchange markets concludes that intervention systematically moves the spot exchange rate only if it is publicly announced, coordinated across countries, and consistent with the underlying stance of fiscal and monetary policy. Over the past 15 years, researchers have also attempted to determine if intervention has any effects on the dispersion and directionality of market views concerning the future exchange rate. These studies usually focus on the variance around the expected future exchange rate}the second moment. In this paper we demonstrate how to use over-the-counter option prices to recover the risk-neutral probability density function (PDF) for the future exchange rate. Using the yen/dollar exchange rate as an example, we calculate measures of dispersion and directionality, such as variance and skewness, from estimated PDFs to test whether intervention by the Japanese Ministry of Finance during the period 1996-2004 had any impact on the higher moments of the exchange rate. We find little or no systematic effect, consistent with the findings of the literature on the spot rate as: Japanese intervention was not publicly announced prior to August 2000, and since that time only publicly announced after the fact, over the past 10 years rarely coordinated across countries and, in hindsight, probably inconsistent with the underlying stance of monetary policy.
This paper examines the extent to which the conditional volatility of stock market returns in a s... more This paper examines the extent to which the conditional volatility of stock market returns in a small, internationally integrated stock market are related to the conditional volatility of financial and business cycle variables. It employs a low frequency monthly dataset for Australia including stock market returns, interest rates, inflation, the money supply, industrial production and the current account deficit over the period from July 1972 to January 1994. , 1 where,
We study the pricing problem for a European call option when the volatility of the underlying ass... more We study the pricing problem for a European call option when the volatility of the underlying asset is random and follows the exponential Ornstein-Uhlenbeck model. The random diffusion model proposed is a two-dimensional market process that takes a log-Brownian motion to describe price dynamics and an Ornstein-Uhlenbeck subordinated process describing the randomness of the log-volatility. We derive an approximate option price that is valid when (i) the fluctuations of the volatility are larger than its normal level, (ii) the volatility presents a slow driving force toward its normal level and, finally, (iii) the market price of risk is a linear function of the log-volatility.
Virtual Volatility, an Elementary New Concept with Surprising Stock Market Consequences
Textbook investors start by predicting the future price distribution, PDF, of a candidate stock (... more Textbook investors start by predicting the future price distribution, PDF, of a candidate stock (or portfolio) at horizon T, e.g. a year hence. A (log)normal PDF with center (=drift =expected return) μT and width (=volatility) σT is often assumed on Central Limit Theorem grounds, i.e. by a random walk of daily (log)price increments δs. The standard deviation, stdev, of historical (ex post) δs `s is usually a fair predictor of the coming year's (ex ante) stdev(δs) = σdaily, but the historical mean E(δs) at best roughly limits the true, to be predicted, drift by μtrueT˜ μhistT ± σhistT. Textbooks take a PDF with σ ˜ σdaily and μ as somehow known, as if accurate predictions of μ were possible. It is elementary and presumably new to argue that an average of PDF's over a range of μ values should be taken, e.g. an average over forecasts by different analysts. We estimate that this leads to a PDF with a `virtual' volatility σ ˜ 1.3σdaily. It is indeed clear that uncertainty in the value of the expected gain parameter increases the risk of investment in that security by most measures, e. g. Sharpe's ratio μT/σT will be 30% smaller because of this effect. It is significant and surprising that there are investments which benefit from this 30% virtual increase in the volatility
We estimate in this paper the market risk implied by the prices of different options traded in th... more We estimate in this paper the market risk implied by the prices of different options traded in the Brazilian stock market. The fundamental theory to handle this problem is the one implied by the Arrow-Debreu contingent claim concept. Using that theory, we are able to construct the term structure of market risk, and to obtain a surface that provides slices for a particular "volatility smile." The methodology that we use follows the one proposed by , which is able to calculate a non-lognormal probability density function (PDF) consistent with the volatility observed in a relatively small sample of option prices. This methodology goes beyond the one proposed originally by , since it does not require log-normality of the PDF nor that volatility remains constant. JEL classification codes: G12, G13
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Papers by Joyce Xue