
on Financial Markets 
Issue of 2005‒03‒06
ten papers chosen by Erik Schloegl School of Mathematical Sciences University of Technology 
By:  Boes,MarkJan; Drost,Feike C.; Werker,Bas J.M. (Tilburg University, Center for Economic Research) 
Abstract:  This paper investigates the effect of closed overnight exchanges on option prices. During the trading day asset prices follow the literature s standard affine model which allows asset prices to exhibit stochastic volatility and random jumps. Independently, the overnight asset price process is modelled by a single jump. We find that the overnight component reduces the variation in the random jump process significantly. However, neither the random jumps nor the overnight jumps alone are able to empirically describe all features of asset prices. We conclude that both random jumps during the day and overnight jumps are important in explaining option prices, where the latter account for about one quarter of total jump risk. 
JEL:  G11 G13 
Date:  2005 
URL:  http://d.repec.org/n?u=RePEc:dgr:kubcen:20051&r=fmk 
By:  Campi,Luciano; Polbennikov,Simon; Sbuelz,Alessandro (Tilburg University, Center for Economic Research) 
Abstract:  Unlike in structural and reducedform models, we use equity as a liquid and observable primitive to analytically value corporate bonds and credit default swaps. Restrictive assumptions on the .rm.s capital structure are avoided. Default is parsimoniously represented by equity value hitting the zero barrier either di¤usively or with a jump, which implies nonzero credit spreads for short maturities. Easy crossasset hedging is enabled. By means of a tersely speci.ed pricing kernel, we also make analytic creditrisk management possible under systematic jumptodefault risk. 
JEL:  G12 G33 
Date:  2005 
URL:  http://d.repec.org/n?u=RePEc:dgr:kubcen:200527&r=fmk 
By:  MARCO FABIO DELZIO 
Abstract:  In this paper we propose a new methodology for calculating the riskneutral default probability of a generic firm XYZ, using equity options prices. This model can be used for the pricing and risk management of corporate bonds and, more in general, credit derivatives. We assume that the market is arbitragefree but not necessarily complete, meaning that many probability measure can exist. We select the 'market' probability measure implied in the equity options prices and use it for pricing single name credit derivatives. Firstly, the equity probability density function is inferred from equity implied volatilities with different strikes and maturities. Then, the corresponding assets density function and default probability are calculated, obtaining the option implied default probability as the main output of the model. We show that the option implied default probability can be expressed as a function of a firm's assets volatility and debt nominal value. Both variables are firm specific, the former being an indicator of business risk, the latter of financial leverage (indeed, financial risk) of the firm XYZ. This model can be used either as a pricing tool, if credit derivatives are not traded, or as a relative value analysis tool in liquid markets. 
Date:  2004–02 
URL:  http://d.repec.org/n?u=RePEc:rtv:ceiswp:198&r=fmk 
By:  Eckhard Platen (School of Finance and Economics, University of Technology, Sydney) 
Abstract:  The paper discusses various roles that the growth optimal portfolio (GOP) plays in finance. For the case of a continuous market we showhow the GOP can be interpreted as a fundamental building block in financial market modeling, portfolio optimization, contingent claim pricing and risk measurement. On the basis of a portfolio selection theorem, optimal portfolios are derived. These allocate funds into the GOP and the savings account. A risk aversion coe±cient is introduced, controlling the amount invested in the savings account, which allows to characterize portfolio strategies that maximize expected utilities. Natural conditions are formulated under which the GOP appears as the market portfolio. A derivation of the intertemporal capital asset pricing model is given without relying on Markovianity, equilibrium arguments or utility functions. Fair contingent claim pricing, with the GOP as numeraire portfolio, is shown to generalize risk neutral and actuarial pricing. Finally, the GOP is described in various ways as the best performing portfolio. 
Keywords:  growth optimal portfolio; portfolio optimization; market portfolio; fair pricing; risk aversion coefficient 
JEL:  G10 G13 
Date:  2005–01–01 
URL:  http://d.repec.org/n?u=RePEc:uts:rpaper:144&r=fmk 
By:  James McCulloch (School of Finance and Economics, University of Technology, Sydney) 
Abstract:  If intraday volume is modelled as a Cox point process, then relative intraday cumulative volume (intraday cumulative volume divided by final total volume) is shown to be a novel generalization of a binomial point process; the doubly stochastic binomial point process. Rescaling the intraday traded volume to a relative volume between 0 (no volume traded) and 1 (daily trading completed) allows empirical intraday volume distribution information for all stocks to be used collectively to estimate and identify the random intensity component of the binomial point process and closely related Cox point process. This is useful for Volume Weighted Average Price (VWAP) traders who require a stochastic model of relative intraday cumulative volume to implement riskoptimal VWAP trading strategies. 
Keywords:  binomial; point process; doubly stochastic; relative volume; Cox process, random probability measure; VWAP; volume weighted average pricing; NYSE; New York Stock Exchange 
Date:  2005–01–01 
URL:  http://d.repec.org/n?u=RePEc:uts:rpaper:146&r=fmk 
By:  XueZhong He (School of Finance and Economics, University of Technology, Sydney); Youwei Li (Department of Econometrics and Operations Research, Tilburg University) 
Abstract:  This paper contributes to the development of recent literature on the explanation power and calibration issue of heterogeneous asset pricing models by presenting a simple stochastic market fraction asset pricing model of two types of traders (fundamentalists and trend followers) under a market maker scenario. It seeks to explain aspects of financial market behaviour (such as market dominance, under and overreaction, profitability and survivability) and to characterize various statistical properties (including autocorrelation structure) of the stochastic model by using the the dynamics of the underlying deterministic system, traders? behaviour and market fractions. Statistical analysis based on Monte Carlo simulations shows that the longrun behaviour and convergence of the market prices, long (short)run profitability of the fundamental (trend following) trading strategy, survivability of chartists, and various under and overreaction autocorrelation patterns of returns can be characterized by the stability and bifurcations of the underlying deterministic system. Our analysis underpins mechanism on various market behaviour (such as under/overreactions), market dominance and stylized facts in high frequency financial markets. 
Keywords:  asset pricing; heterogeneous beliefs; market fraction; stability; bifurcation; market behaviour; profitability; survivability; autocorrelation 
Date:  2005–01–01 
URL:  http://d.repec.org/n?u=RePEc:uts:rpaper:147&r=fmk 
By:  XueZhong He (School of Finance and Economics, University of Technology, Sydney); Youwei Li (Department of Econometrics and Operations Research, Tilburg University) 
Abstract:  Longrange dependence in volatility is one of the most prominent examples of applications in financial market research involving universal power laws. Its characterization has recently spurred attempts at theoretical explanation of the underlying mechanism. This paper contributes to this recent development by analyzing a simple market fraction asset pricing model with two types of traders?fundamentalists who trade on the price deviation from estimated fundamental value and trend followers who follow a trend which is updated through a geometric learning process. Our analysis shows that the heterogeneity, trend chasing through learning, and the interplay of noisy processes and a stable deterministic equilibrium can be the source of powerlaw distributed fluctuations. Statistical analysis based on Monte Carlo simulations are conducted to characterize the long memory. Realistic estimates of the powerlaw decay indices and the (FI)GARCH parameters are found. 
Keywords:  asset pricing; fundamentalists and trend followers; market fraction; stability; learning; long memory 
JEL:  C15 D84 G12 
Date:  2005–01–01 
URL:  http://d.repec.org/n?u=RePEc:uts:rpaper:148&r=fmk 
By:  Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Hing Hung (School of Finance and Economics, University of Technology, Sydney); ThuyDuong To (School of Finance and Economics, University of Technology, Sydney) 
Abstract:  This paper considers the dynamics for interest rate processes within a multifactor Heath, Jarrow and Morton (1992) specification. Despite the flexibility of and the notable advances in theoretical research about the HJM models, the number of empirical studies is still inadequate. This paucity is principally because of the difficulties in estimating models in this class, which are not only highdimensional, but also nonlinear and involve latent state variables. This paper treats the estimation of a fairly broad class of HJMmodels as a nonlinear filtering problem, and adopts the local linearization filter of Jimenez and Ozaki (2003), which is known to have some desirable statistical and numerical features, to estimate the model via the maximum likelihood method. The estimator is then applied to the interbank offeredrates of the U.S, U.K, Australian and Japanese markets. The twofactor model, with the factors being the level and the slope effect, is found to be a reasonable choice for all of the markets. However, the contribution of each factor towards overall variability of the interest rates and the financial reward each factor claims differ considerably from one market to another. 
Keywords:  term structure; HeathJarrowMorton; local linearization; filtering 
JEL:  C51 E43 G12 
Date:  2005–01–01 
URL:  http://d.repec.org/n?u=RePEc:uts:rpaper:151&r=fmk 
By:  Bernard Cornet (Department of Economics, The University of Kansas); Lionel De Boisdeffre (CERMSEM, Maison des Sciences Economiques, Universite de Paris 1) 
Abstract:  In a financial economy with asymmetric information and incomplete markets, we study how agents, having no model of how equilibrium prices are determined, may still refine their information by eliminating sequentially ¡°arbitrage state(s)¡±, namely, the state(s) which would grant the agent an arbitrage, if realizable. 
Keywords:  Arbitrage, incomplete markets, asymmetric information, information revealed by prices. 
JEL:  D52 
Date:  2005–02 
URL:  http://d.repec.org/n?u=RePEc:kan:wpaper:200504&r=fmk 
By:  Laura Angeloni (Dipartimento di Matematica e Informatica, Universita degli Studi di Perugia); Bernard Cornet (Department of Economics, The University of Kansas) 
Abstract:  We consider the model of a stochastic financial exchange economy where time and uncertainty are represented by a finite eventtree of length T. We provide a general existence result of financial equilibria, which allows to cover several important cases of financial structures considered in the literature, such as nominal and numeraire assets, when consumers may have constraints on their portfolios. 
Date:  2005–02 
URL:  http://d.repec.org/n?u=RePEc:kan:wpaper:200506&r=fmk 