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on Risk Management |
| By: | Ole E. Barndorff-Nielsen (University of Aarhus); Neil Shephard (Nuffield College, Oxford University) |
| Abstract: | We will review the econometrics of non-parametric estimation of the components of the variation of asset prices. This very active literature has been stimulated by the recent advent of complete records of transaction prices, quote data and order books. In our view the interaction of the new data sources with new econometric methodology is leading to a paradigm shift in one of the most important areas in econometrics: volatility measurement, modelling and forecasting. We will describe this new paradigm which draws together econometrics with arbitrage free financial economics theory. Perhaps the two most influential papers in this area have been Andersen, Bollerslev, Diebold and Labys(2001) and Barndorff-Nielsen and Shephard(2002), but many other papers have made important contributions. This work is likely to have deep impacts on the econometrics of asset allocation and risk management. One of our observations will be that inferences based on these methods, computed from observed market prices and so under the physical measure, are also valid as inferences under all equivalent measures. This puts this subject also at the heart of the econometrics of derivative pricing. One of the most challenging problems in this context is dealing with various forms of market frictions, which obscure the efficient price from the econometrician. Here we will characterise four types of statistical models of frictions and discuss how econometricians have been attempting to overcome them. |
| Date: | 2005–07–14 |
| URL: | http://d.repec.org/n?u=RePEc:nuf:econwp:0516&r=rmg |
| By: | Nicola Cetorelli; Linda Goldberg |
| Abstract: | U.S. banks have substantial exposure to foreign markets such as Europe and Latin America. In this paper, we show how the amounts and forms of these exposures have evolved over time and note the changes in embodied risks taken through banks' cross-border activity, local claims, and derivative positions. Our findings vary with the type of U.S. bank. Compared with other banks, money-center banks tend to have a greater share of their assets in foreign exposures. Some of money-center banks' exposure to riskier countries, particularly Latin American countries, is achieved through the activities of local branches and subsidiaries that take on liabilities as well as assets, a strategy that reduces their bank transfer risk accordingly. As a share of total international exposures, the transfer risk assumed by money-center banks tends to be significantly lower than that of other banks. |
| Keywords: | Banks and banking, International ; International finance ; Bank investments ; Branch banks |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:240&r=rmg |
| By: | Martin Lettau; Stijn Van Nieuwerburgh |
| Abstract: | Evidence of stock return predictability by financial ratios is still controversial, as documented by inconsistent results for in-sample and out-of-sample regressions and by substantial parameter instability. This paper shows that these seemingly incompatible results can be reconciled if the assumption of a fixed steady-state mean of the economy is relaxed. We find strong empirical evidence in support of shifts in the steady-state and propose simple methods to adjust financial ratios for such shifts. The forecasting relationship of adjusted price ratios and future returns is statistically significant and stable over time. We also show that shifts in the steady-state are responsible for the parameter instability and poor out-of-sample performance of unadjusted price ratios that are found in the data. Our conclusions hold for a variety of financial ratios and are robust to changes in the econometric technique used to estimate shifts in the steady-state. |
| JEL: | G1 G12 G11 C53 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12109&r=rmg |
| By: | Paul Söderlind |
| Abstract: | This paper studies if the consumption-based asset pricing model can explain the cross-section of expected returns. The CRRA model and several refinements (habit persistence and idiosyncratic shocks) all imply that the conditional expected return is linearly increasing in the asset's conditional covariance with consumption growth. Results from quarterly data on the 25 Fama-French portfolios suggest that the model has serious problems: there are large and systematic pricing errors. In addition, the estimated time-varying effective risk aversion coefficients appear implausible and are unrelated with most candidates for habit persistence and idiosyncratic risk. |
| JEL: | G12 E13 E32 |
| Date: | 2006–03 |
| URL: | http://d.repec.org/n?u=RePEc:usg:dp2006:2006-07&r=rmg |
| By: | Jean-Philippe Bouchaud (Science & Finance, Capital Fund Management; CEA Saclay;); Julien Kockelkoren (Capital Fund Management); Marc Potters (Science & Finance, Capital Fund Management) |
| Abstract: | Stock prices are observed to be random walks in time despite a strong, long term memory in the signs of trades (buys or sells). Lillo and Farmer have recently suggested that these correlations are compensated by opposite long ranged fluctuations in liquidity, with an otherwise permanent market impact, challenging the scenario proposed in Quantitative Finance 4, 176 (2004), where the impact is *transient*, with a power-law decay in time. The exponent of this decay is precisely tuned to a critical value, ensuring simultaneously that prices are diffusive on long time scales and that the response function is nearly constant. We provide new analysis of empirical data that confirm and make more precise our previous claims. We show that the power-law decay of the bare impact function comes both from an excess flow of limit order opposite to the market order flow, and to a systematic anti-correlation of the bid-ask motion between trades, two effects that create a `liquidity molasses' which dampens market volatility. |
| JEL: | G10 |
| Date: | 2004–06 |
| URL: | http://d.repec.org/n?u=RePEc:sfi:sfiwpa:500063&r=rmg |
| By: | Lisa Borland (Evnine-Vaughan Associates, Inc.); Jean-Philippe Bouchaud (Science & Finance, Capital Fund Management; CEA Saclay;); Jean-Francois Muzy (Centre de Recherche Paul Pascal, Pessac, FRANCE); Gilles Zumbach (Consulting in Financial Research) |
| Abstract: | This is a short review in honor of B. Mandelbrot's 80st birthday, to appear in W ilmott magazine. We discuss how multiplicative cascades and related multifractal ideas might be relevant to model the main statistical features of financial time series, in particular the intermittent, long-memory nature of the volatility. We describe in details the Bacry-Muzy-Delour multifractal random walk. We point out some inadequacies of the current models, in particular concerning time reversal symmetry, and propose an alternative family of multi-timescale models, intermediate between GARCH models and multifractal models, that seem quite promising. |
| JEL: | G10 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:sfi:sfiwpa:500061&r=rmg |