Source : NEP (New Economics Papers) | RePEc

**Jump Tails, Extreme Dependencies, and the Distribution of Stock Returns**

Date: | 2010-09-10 |

By: | Tim Bollerslev (Department of Economics, Duke University, and NBER and CREATES) Viktor Todorov (Department of Finance, Kellogg School of Management, Northwestern University) |

URL: | http://d.repec.org/n?u=RePEc:aah:create:2010-64&r=fmk |

We provide a new framework for estimating the systematic and idiosyncratic jump tail risks in financial asset prices. The theory underlying our estimates are based on in-fill asymptotic arguments for directly identifying the systematic and idiosyncratic jumps, together with conventional long-span asymptotics and Extreme Value Theory (EVT) approximations for consistently estimating the tail decay parameters and asymptotic tail dependencies. On implementing the new estimation procedures with a panel of highfrequency intraday prices for a large cross-section of individual stocks and the aggregate S&P 500 market portfolio, we find that the distributions of the systematic and idiosyncratic jumps are both generally heavy-tailed and not necessarily symmetric. Our estimates also point to the existence of strong dependencies between the market-wide jumps and the corresponding systematic jump tails for all of the stocks in the sample. We also show how the jump tail dependencies deduced from the high-frequency data together with the day-to-day temporal variation in the volatility are able to explain the “extreme” dependencies vis-a-vis the market portfolio. | |

Keywords: | Extreme events, jumps, high-frequency data, jump tails, non-parametric estimation, stochastic volatility, systematic risks, tail dependence. |

JEL: | C13 |

**Models for Heavy-tailed Asset Returns**

Date: | 2010-09 |

By: | Borak, Szymon Misiorek, Adam Weron, Rafal |

URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:25494&r=fmk |

Many of the concepts in theoretical and empirical finance developed over the past decades – including the classical portfolio theory, the Black-Scholes-Merton option pricing model or the RiskMetrics variance-covariance approach to VaR – rest upon the assumption that asset returns follow a normal distribution. But this assumption is not justified by empirical data! Rather, the empirical observations exhibit excess kurtosis, more colloquially known as fat tails or heavy tails. This chapter is intended as a guide to heavy-tailed models. We first describe the historically oldest heavy-tailed model – the stable laws. Next, we briefly characterize their recent lighter-tailed generalizations, the so-called truncated and tempered stable distributions. Then we study the class of generalized hyperbolic laws, which – like tempered stable distributions – can be classified somewhere between infinite variance stable laws and the Gaussian distribution. Finally, we provide numerical examples. | |

Keywords: | Heavy-tailed distribution; Stable distribution; Tempered stable distribution; Generalized hyperbolic distribution; Asset return; Random number generation; Parameter estimation |

JEL: | C16 |

**Towards a volatility index for the Italian stock market**

Date: | 2010-09 |

By: | Silvia Muzzioli |

URL: | http://d.repec.org/n?u=RePEc:mod:wcefin:10091&r=fmk |

The aim of this paper is to analyse and empirically test how to unlock volatility information from option prices. The information content of three option based forecasts of volatility: Black-Scholes implied volatility, model-free implied volatility and corridor implied volatility is addressed, with the ultimate plan of proposing a new volatility index for the Italian stock market. As for model-free implied volatility, two different extrapolation techniques are implemented. As for corridor implied volatility, five different corridors are compared. Our results, which point to a better performance of corridor implied volatilities with respect to both Black-Scholes implied volatility and model-free implied volatility, are in favour of narrow corridors. The volatility index proposed is obtained with an overall 50% cut of the risk neutral distribution. The properties of the volatility index are explored by analysing both the co ntemporaneous relationship between implied volatility changes and market returns and the usefulness of the proposed index in forecasting future market returns. | |

Keywords: | volatility index; Black-Scholes implied volatility; model-free implied volatility; corridor implied volatility; implied binomial trees |

JEL: | G13 |

**Do Derivative Markets Contain Useful Information for Signaling « Hot Money » Flows?**

Date: | 2010-05 |

By: | Joseph K. W. Fung (Hong Kong Institute for Monetary Research and Hong Kong Baptist University) Robert I. Webb (Hong Kong Institute for Monetary Research and University of Virginia) Wing H. Chan (City University of Hong Kong and Wilfrid Laurier University) |

URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:122010&r=fmk |

This study examines whether information from derivative markets is useful for signaling « hot money » and other large capital flows in an economy where the monetary authority pursues a policy of exchange rate stability. Specifically, this study examines the information content of various Hong Kong traded derivative securities for signaling changes in the aggregate balance of the Hong Kong banking system during a period of intense IPO activity and speculation on the revaluation of the renminbi. The impact of the introduction of the Hong Kong Monetary Authority’s (HKMA) Convertibility Undertakings on the dynamic relationships among capital flows, stock market volatility and stock market turnover is also examined. Finally, the implications for monetary policymakers in potentially using information from derivative markets are assessed. The results show that derivative markets contain useful information for signaling « hot money » flows. Granger causality tests from a VAR model show that Hong Kong dollar forward and RMB non-deliverable forward (NDF) prices predict future variation in the aggregate balance. Moreover, changes in aggregate balance has a significant impact on Hong Kong’s interbank rates. The findings also suggest that the introduction of the May 18, 2005 Convertibility Undertakings may have increased the credibility of the Linked Exchange Rate System by discouraging the use of the Hong Kong dollar and Hong Kong dollar denominated assets as speculative vehicles on RMB denominated assets. |

**The EU Stress Test and Sovereign Debt Exposures**

Date: | 2010-08 |

By: | Adrian Blundell-Wignall Patrick Slovik |

URL: | http://d.repec.org/n?u=RePEc:oec:dafaad:4-en&r=fmk |

This working paper’s quantifications show that most sovereign debt is held on the banking books of banks, whereas the EU stress test considered only their small trading book exposures. It discusses why sovereign debt held in the banking book cannot be ignored by investors and creditors, because of: (a) recovery values in the event of individual bank failures; and (b) fiscal sustainability and structural competitiveness issues which mean the market cannot give a zero probability to debt restructurings beyond the period of the stress test and/or the period after which the role of the European Financial Stability Facility Special Purpose Vehicle (EFSF SPV) comes to an end. How the SPV could operate to shift sovereign risk from banks to the public sector is also an important part of the discussion. | |

Keywords: | financial stability |

JEL: | E62 |