Felix Goltz, Lionel Martellini and Koray D. Simsek The focus of this paper is to determine what fraction a myopic risk-averse investor should allocate to investment strategies with convex exposure to stock market returns in a general economy with stochastically time-varying interest rates and equity risk premium. Our conclusion is that typical investors should optimally… Read more
Articles
HOW DOES INVESTOR SENTIMENT AFFECT THE CROSS-SECTION OF STOCK RETURNS?
Malcolm Baker, Johnathan Wang and Jeffrey Wurgler Broad waves of investor sentiment should have larger impacts on securities that are more difficult to value and to arbitrage. Consistent with this intuition, we find that when an index of investor sentiment takes low values, small, young, high volatility, unprofitable, nondividend-paying, extreme growth, and distressed stocks earn… Read more
ARE ANALYSTS ALL ALIKE? IDENTIFYING EARNINGS FORECASTING ABILITY
Louis K. C. Chan, David Ikenberry, Josef Lakonishok and Sangwoo Lee Investors and the financial media apparently believe that some Wall Street equity analysts’ research is superior to others’. We examine whether such quality differentials exist, in terms of analysts’ ability to forecast earnings accurately, and whether these differentials are identifiable on an ex ante… Read more
INTEREST RATE MODELS’ IMPLIED VOLATILITY FUNCTION STOCHASTIC MOVEMENTS
Thomas S. Y. Ho and Blessing Mudavanhu This paper presents a one-factor and a two-factor arbitrage-free interest rate models with parsimonious implied volatility functions. The models are empirically tested on the entire swaption surface in three currencies (US dollar, Euro, and Japanese yen) over a 5-year period. They are shown to be robust in explaining… Read more
CONTINGENT CLAIMS APPROACH TO MEASURING AND MANAGING SOVEREIGN CREDIT RISK
Dale F. Gray, Robert C. Merton and Zvi Bodie This paper proposes a new approach to measure, analyze, and manage sovereign risk based on the theory and practice of modern contingent claims analysis (CCA). The paper provides a new framework for adapting the CCA model to the sovereign balance sheet in a way that can… Read more
THE PRICING OF CREDIT DEFAULT SWAPS DURING DISTRESS
Jochen R. Andritzky and Manmohan Singh Credit default swaps (CDS) provide the buyer with insurance against certain types of credit events by entitling him to exchange any of the bonds permitted as deliverable against their par value. Unlike bonds, whose risk spreads are assumed to be the product of default risk and loss rate, CDS… Read more
A BRIEF REVIEW OF “THE BASIS”
James Batterman Credit derivatives provide an alternative to the cash market, allowing investors to manage exposure to a wide range of entities. In a brief case study looking at several relatively volatile corporate names, we set out to describe, in general terms, the nature and behavior of the relationship of CDS, LCDS, and bonds over… Read more
WHAT HAPPENED TO THE QUANTS IN AUGUST 2007?
Amir E. Khandani and Andrew W. Lo During the week of August 6, 2007, a number of quantitative long/short equity hedge funds experienced unprecedented losses. Based on TASS hedge-fund data and simulations of a specific long/short equity strategy, we hypothesize that the losses were initiated by the rapid “unwind” of one or more sizable quantitative… Read more
WHAT EVERY INVESTOR SHOULD KNOW ABOUT COMMODITIES PART II: MULTIVARIATE RETURN ANALYSIS
Harry M. Kat and Roel C. A. Oomen In this paper, we study the multivariate return properties of a large variety of commodity futures. We find that between commodity groupings (such as metals, energy, etc.) correlations are very low and mostly insignificant whereas within groups they tend to be much stronger. In addition, commodity futures… Read more
ON THE RELATIVE PERFORMANCE OF MULTI-STRATEGY AND FUNDS OF HEDGE FUNDS
Vikas Agarwal and Jayant R. Kale Recently, there has been explosive growth in two products from the hedge fund industry—multi-strategy (MS) funds and funds of hedge funds (FOFs), both of which offer diversification across different hedge fund strategies. In well-functioning markets, both investment vehicles should offer similar returns. Over the period 1994–2004, we find that… Read more