The Role of Derivatives in Asset Pricing
Baltimore, MD | Saturday, June 4, 2016
CFTC Chief Economist
Sayee Srinivasan joined the Commission in 2012. Prior to joining the Commission, he has worked with the Chicago Mercantile Exchange, the Bombay Stock Exchange, the National Stock Exchange of India, and OptiMark Technologies focusing on market and product design, trading rules, and business development across a broad range of asset classes, and both cash and derivatives markets. His research interest includes regulatory policy development on issues related to pre-trade, trade, and post trade technology, systems, processes and risk management. He has an undergraduate degree in Accounting and Master’s degree in Finance from University of Bombay, and Master’s and Doctorate in Economics from the University of Texas at Austin.
Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets (with Scott Joslin and Sophie X. Ni)
Abstract: We propose a new measure of financial intermediary constraints based on how the intermediaries manage their tail risk exposures. Using a unique dataset for the trading activities in the market of deep out-of-the-money S&P 500 put options, we identify periods when the variations in the net amount of trading between financial intermediaries and public investors are likely to be mainly driven by shocks to intermediary constraints. We then infer tightness of intermediary constraints from the quantities of option trading during such periods. We show that a tightening of intermediary constraint according to our measure is associated with increasing option expensiveness, higher risk premia for a wide range of financial assets, deterioration in funding liquidity, and deleveraging of broker-dealers
Hui Chen is an Associate Professor of Finance at the MIT Sloan School of Management. His research focuses on asset pricing and its connections with corporate finance. Chen is particularly interested in the interactions between the macro economy and term structure, credit risk, and corporate financing or investment decisions. His recent research projects include application of business cycle models to explain corporate financing behavior and corporate bond pricing, as well as analysis of the effects of incomplete markets on entrepreneurial financing and investments. Chen holds a BA in economics and finance from Zhongshan University, an MS in mathematics from the University of Michigan, and a PhD in finance from the University of Chicago.
University of Toronto
Option-Based Estimation of the Price of Co-Skewness and Co-Kurtosis Risk (with Mathieu Fournier, Kris Jacob, Mehdi Karoui)
Abstract: We show that the prices of risk for factors that are nonlinear in the market return are readily obtained using index option prices. The price of co-skewness risk corresponds to the market variance risk premium, and the price of co-kurtosis risk corresponds to the market skewness risk premium. Option-based estimates of the prices of risk lead to reasonable values of the associated risk premia. An out-of-sample analysis of factor models with co-skewness and co-kurtosis risk indicates that the new estimates of the price of risk improve the models' performance.
Peter Christoffersen holds the TSX Chair in Capital Market, publishes in leading finance and econometrics journals, and is the author of Elements of Financial Risk Management. He serves as an Associate Editor of the Review of Finance and the Journal of Financial Econometrics. He is a Fellow of the Bank of Canada and until recently served on the Model Validation Council at the Federal Reserve Board. Peter formerly taught at McGill University and worked as an Economist at the IMF. You can find him on the web at: www.christoffersen.com.
University of Wisconsin-Madison
Explaining the Negative Returns to Volatility Claims: An Equilibrium Approach (with Yue Wu)
Abstract: We study the returns to investing in VIX futures, VIX Exchange Traded Notes (ETNs) and variance swaps. We document substantial negative return premiums for these assets. For example, the constant maturity portfolio of one-month VIX futures loses about 30% per year over our sample period (2006-2013). We investigate if these findings are consistent with a notion of dynamic equilibrium. We derive a model based on present value computation that endogenizes stock prices, the VIX index and its associated derivative contracts. The model explains the negative return premiums as well as several other stylized features of the VIX futures, ETNs, and variance swap data.
Bjørn Eraker is an associate professor in the Finance, Investment and Banking Department of the Wisconsin School of Business.His research interests include asset pricing, derivatives, econometrics of financial markets, and equilibrium modeling. Eraker has been published in several journals, including the Journal of Finance, Mathematical Finance, the Journal of Business and Economic Statistics, and the Journal of Empirical Finance. Prior to joining Wisconsin, he was on the faculty of Duke University, where he was an assistant professor in the Department of Economics. He received his Ph.D. from the University of Chicago. He also earned a master's in economics and business from the Norwegian School of Economics and Business Administration and a master of management from the Norwegian School of Management.
University of Houston
Volatility and Expected Option Returns (with Guanglian Hu)
Abstract: We analyze the relation between expected option returns and the volatility of the underlying securities. In the Black-Scholes and stochastic volatility models, the expected return from holding a call (put) option is a decreasing (increasing) function of the volatility of the underlying. These predictions are strongly supported by the data. In the cross-section of stock option returns, returns on call (put) option portfolios decrease (increase) with underlying stock volatility. This strong negative (positive) relation between call (put) option returns and volatility is not due to cross-sectional variation in expected stock returns. It holds in various option samples with different maturities and moneyness, and it is robust to alternative measures of underlying volatility and different weighting methods. Time-series evidence also supports the predictions from option pricing theory: Future returns on S&P 500 index call (put) options are negatively (positively) related to S&P 500 index volatility.
Kris Jacobs is the Bauer Professor of Finance at the University of Houston. He obtained his undergraduate degree at the Catholic University of Leuven and his Ph.D. at the University of Pittsburgh. His research is widely published in leading journals in finance and economics, and focuses on the areas of investments, asset pricing, derivatives, and credit risk.
Bryan T. Kelly
University of Chicago
Excess Volatility: Beyond Discount Rates (with Stefano Giglio)
Abstract: We document a form of excess volatility that is irreconcilable with standard models of prices, even after accounting for variation in discount rates. We compare prices of claims on the same cash flow stream but with different maturities. Standard models impose precise internal consistency conditions on the joint behavior of long and short maturity claims and these are strongly rejected in the data. In particular, long maturity prices are significantly more variable than justified by the behavior at short maturities. Our findings are pervasive. We reject internal consistency conditions in all term structures that we study, including equity options, currency options, credit default swaps, commodity futures, variance swaps, and inflation swaps.
Bryan T. Kelly joined Chicago Booth in 2010 as Assistant Professor of Finance after earning his PhD and MPhil in finance at New York University's Leonard N. Stern School of Business. His research interests include theoretical and empirical asset pricing; models of tail risk, volatility and correlation dynamics; and asymmetric information in asset markets. He is a faculty research fellow at the NBER and an associate editor of the Journal of Financial Econometrics. Kelly is the recipient of the 2012 AQR Insight Award, and has received various other research awards including the JPMorgan Best Paper Award from the WFA, the Q-group Research Award, the Arnold Zellner Award (honorable mention), the David M. Graifman award for best dissertation in finance at NYU Stern, the Herman E. Kroos award for best dissertation across disciplines at NYU Stern, and the Shmuel Kandel Prize, and various research grants. Prior to his doctoral studies, Kelly worked in Morgan Stanley's investment banking division and in the sales and trading division of UBS. He holds an M.A. in economics from University of California, San Diego and an A.B. in economics (with honors) from the University of Chicago.
University of Pennsylvania
Good and Bad Variance Premia and Expected Returns (with Mete Kilic)
Abstract: We measure “good” and “bad” variance premia that capture risk compensations for the realized variation in positive and negative market returns, respectively. The two variance premium components jointly predict excess returns over the next 1 and 2 years with statistically significant negative (positive) coefficients on the good (bad) component. The R2s reach about 10% for aggregate equity and portfolio returns and 20% for corporate bond returns. To explain the new empirical evidence, we develop an economic model which underscores the difference in investors’ risk attitudes towards upside and downside uncertainty risks.
Ivan Shaliastovich is an Assistant Professor in Finance department at The Wharton School, University of Pennsylvania. He joined Wharton in 2009, after earning his PhD in Economics at Duke University. Prior to his doctorate, he studied at the American University in Bulgaria. Ivan's research interests include asset pricing, macro-finance, and financial econometrics. He has published in leading finance journals, such as the Journal of Finance, the Review of Financial Studies, and the Journal of Financial Economics.
University of Pennsylvania
Option prices in a model with stochastic disaster risk (with Sang Byung Seo)
Abstract: Contrary to the Black-Scholes model, volatilities implied by index option prices depend on the exercise price of the option and are often higher than realized volatilities. We explain both facts in the context of a model that can also explain the mean and volatility of equity returns. Our model assumes a small risk of a rare disaster that is calibrated based on the international data on large consumption declines. We allow the risk of this rare disaster to be stochastic, which turns out to be crucial to the model's ability to explain both equity volatility and option prices. We explore dierent specifications for the stochastic rare disaster probability and show that the data favor a multifrequency process. Finally, we show that the model can simultaneously t the time series of option prices and equities.
Jessica Wachter is the Richard B. Worley Professor of Financial Management at the Wharton School of Business of the University of Pennsylvania. She holds a PhD in Business Economics and an undergraduate degree in Mathematics from Harvard University. She currently serves as an associate editor at the Journal of Economic Theory and as a member of the board of directors of the American Finance Association. She is a founding member of the advisory board of Her research interests include asset pricing models that incorporate rare events, models of portfolio allocation, and financial econometrics. She has published numerous papers in the Journal of Finance, the Journal of Financial Economics, the Review of Financial Studies, and other journals.
City University of New York
Designing Trading Strategies Under Dynamic Relative Valuation
Abstract: We propose a new derivative pricing framework that builds upon partial specifications of near-term dynamics of many derivative securities, and discusses its implications on common derivative trading strategies in equities, currencies, and fixed income.
Liuren Wu is the Wollman Distinguished Professor of Finance at Zicklin School of Business, Baruch College, City University of New York. Professor Wu's research interests include option pricing, credit risk and term structure modeling, market microstructure, and general asset pricing. During the past decade, Professor Wu has published over 40 articles, many of them in top finance journals. Professor Wu has also worked extensively as consultants in the finance industry, including Bloomberg, Morgan Stanley, Royal Bank of Canada, and several fixed income, equity, and equity options hedge funds and market making firms. As a consultant, he has developed trading strategies, risk management procedures, and quantitative models for pricing fixed income and equity derivative securities.
University of Chicago
What Drives High Frequency Index Option Prices? (with Yacine Ait-Sahalia)
Dacheng Xiu studies financial econometrics with an emphasis on exploring high-frequency financial data. Xiu earned his PhD and MA in applied mathematics from Princeton University, where he taught and conducted research at the Bendheim Center for Finance. Additionally, he holds a BS in mathematics from the University of Science and Technology of China in Hefei, China. His work has appeared in Econometrica, the Journal of Econometrics, the Journal of the American Statistical Association, and Journal of Business & Economic Statistics. Xiu joined the University of Chicago faculty in 2011.