nep-fmk New Economics Papers
on Financial Markets
Issue of 2015‒03‒13
four papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Volatility of aggregate volatility and hedge funds returns By Agarwal, Vikas; Arisoy, Y. Eser; Naik, Narayan Y.
  2. A Directional Multivariate Value at Risk By Raúl Torres; Rosa E. Lillo; Henry Laniado
  3. A joint affine model of commodity futures and US Treasury yields By Chin, Michael; Liu, Zhuoshi
  4. Sovereign Default Risk and State-Owned Bank Fragility in Emerging Markets By Deev, Oleg; Hodula, Martin

  1. By: Agarwal, Vikas; Arisoy, Y. Eser; Naik, Narayan Y.
    Abstract: This paper investigates empirically whether uncertainty about the expected returns on the market portfolio can explain the performance of hedge funds both in the cross-section and over time. We measure uncertainty via volatility of aggregate volatility (VOV) and construct an investable version of this measure by computing monthly returns on lookback straddles written on the VIX index. We find that VOV exposure is a significant determinant of hedge fund returns at the overall index level, at different strategy levels, and at an individual fund level. We find that funds with low (more negative) VOV betas outperform funds with high VOV betas by 1.62% per month. After controlling for a large set of fund characteristics, we document a robust and significant negative risk premium for VOV exposure in the crosssection of hedge fund returns. We further show that strategies with less negative VOV betas outperform their counterparts during the financial crisis period when uncertainty about expected returns was at its highest. On the contrary, strategies with more negative VOV betas generate superior returns when uncertainty in the market is less. Furthermore, the variation in the VOV betas is consistent with the risk-taking incentives of hedge funds arising from the different fund characteristics including their contractual features.
    Keywords: uncertainty,volatility of volatility,hedge funds,performance
    JEL: G10 G11 C13
    Date: 2015
  2. By: Raúl Torres; Rosa E. Lillo; Henry Laniado
    Abstract: In economics, insurance and finance, value at risk (VaR) is a widely used measure of the risk of loss on a specific portfolio of financial assets. For a given portfolio, time horizon, and probability alfa, the 100alfa% VaR is defined as a threshold loss value, such that the probability that the loss on the portfolio over the given time horizon exceeds this value is alfa. That is to say, it is a quantile of the distribution of the losses, which has both good analytic properties and easy interpretation as a risk measure. However, its extension to the multivariate framework is not unique because a unique definition of multivariate quantile does not exist. In the current literature, the multivariate quantiles are related to a specific partial order considered in Rn, or to a property of the univariate quantile that is desirable to be extended to Rn. In this work, we introduce a multivariate value at risk as a vector-valued directional risk measure, based on a directional multivariate quantile, which has recently been introduced in the literature. The directional approach allows the manager to consider external information or risk preferences in her/his analysis. We have derived some properties of the risk measure and we have compared the univariate VaR over the marginals with the components of the directional multivariate VaR. We have also analyzed the relationship between some families of copulas, for which it is possible to obtain closed forms of the multivariate VaR that we propose. Finally, comparisons with other alternative multivariate VaR given in the literature, are provided in terms of robustness.
    Date: 2015–01
  3. By: Chin, Michael (Bank of England); Liu, Zhuoshi (Bank of England)
    Abstract: We derive a general joint affine term structure model of US government bond yields and the convenience yields on physical commodities. We apply this framework separately to oil and gold. Our results show clear links between bond and commodity markets, since bond factors play a significant role in the pricing of the convenience yield term structure. Our framework allows us to decompose the term structure of futures prices into expectations of future spot prices and risk premia components. We estimate that the risk premium in oil futures has been negative over the 1980s and 1990s, and turned positive in the mid-2000s, consistent with a declining role for supply shocks in the oil market over this period. In contrast, we estimate that the gold risk premium is mostly positive throughout the sample period.
    Keywords: Commodity futures; gold; oil; risk premium; convenience yields; affine term structure model; Treasury yields
    JEL: E43 G13 Q02 Q40
    Date: 2015–03–06
  4. By: Deev, Oleg; Hodula, Martin
    Abstract: In this paper we investigate the interdependence of the sovereign default risk and banking system fragility in two major emerging markets, China and Russia, using credit default swaps as a proxy for default risk. Both countries’ banking industries have strong ties with their governments and public sector, even after a series of significant reforms in the last two decades. Our analysis is built on the case studies of each country’s two biggest banks. We employ bivariate vector autoregressive (VAR) and vector error correction (VECM) framework to analyse the short- and long-run dynamics of the chosen CDS prices. We use Granger causality to describe the direction of the discovered dynamics. We find evidence of a stable long-run relationship between sovereign and bank CDS spreads in the chosen time period. The more stable relationship is found in cases, where biggest state-owned universal banks in emerging markets are closely managed by the government. But the fragility of those banks does not directly affect the state of public finance. However, in cases, where state-owned banks directly participate in large governmental projects, the banking fragility may result in deteriorations of state funds, while raising the risk of sovereign default.
    Keywords: sovereign default risk, bank default risk, CDS, emerging markets, risk transfer, financial stability
    JEL: G18 G21
    Date: 2014–12

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