Jump Risk and Option Liquidity in an Incomplete Market PDF Download
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Author: PeiLin Billy Hsieh
Publisher:
ISBN:
Category :
Languages : en
Pages : 45
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Book Description
We investigate the effects of return jumps on option bid-ask spreads measured in implied volatility. To explain bid-ask spread quoting behavior, we construct a general model with market makers trading in an incomplete market in which a Bernoulli-type jump could occur. Following a numerical analysis of equilibrium, we apply a nonparametric method to identify the jump components and then test the validity of our theoretical findings. Our results strongly suggest that, at a low jump arrival rate, the dynamic hedging of diffusion movement outperforms static hedging which considers both diffusion and jump risks together, and market makers should apply a dynamic hedging strategy most of the time. A testable implication of quoting behavior, which assumes market makers apply dynamic hedging, is ratified in our empirical work. Additionally, our regression shows that bid-ask volatility spread increases by 0.742% for a one-standard-deviation increase in our defined nonlinear jump factor and by 0.247% for the factor of diffusion volatility. We obtain a R2 value above 80%, and the jump risk factor is characterized by t-statistics above 7, whereas diffusion volatility is only marginally significant. Thus, this paper theoretically explains why and how the jump risk affects options' bid-ask spread and empirically shows that the jump risk influences options' liquidity both statistically and economically.
Author: PeiLin Billy Hsieh
Publisher:
ISBN:
Category :
Languages : en
Pages : 45
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Book Description
We investigate the effects of return jumps on option bid-ask spreads measured in implied volatility. To explain bid-ask spread quoting behavior, we construct a general model with market makers trading in an incomplete market in which a Bernoulli-type jump could occur. Following a numerical analysis of equilibrium, we apply a nonparametric method to identify the jump components and then test the validity of our theoretical findings. Our results strongly suggest that, at a low jump arrival rate, the dynamic hedging of diffusion movement outperforms static hedging which considers both diffusion and jump risks together, and market makers should apply a dynamic hedging strategy most of the time. A testable implication of quoting behavior, which assumes market makers apply dynamic hedging, is ratified in our empirical work. Additionally, our regression shows that bid-ask volatility spread increases by 0.742% for a one-standard-deviation increase in our defined nonlinear jump factor and by 0.247% for the factor of diffusion volatility. We obtain a R2 value above 80%, and the jump risk factor is characterized by t-statistics above 7, whereas diffusion volatility is only marginally significant. Thus, this paper theoretically explains why and how the jump risk affects options' bid-ask spread and empirically shows that the jump risk influences options' liquidity both statistically and economically.
Author: Deniz Ozenbas
Publisher: Springer Nature
ISBN: 3030748170
Category : Business enterprises
Languages : en
Pages : 111
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Book Description
This open access book addresses four standard business school subjects: microeconomics, macroeconomics, finance and information systems as they relate to trading, liquidity, and market structure. It provides a detailed examination of the impact of trading costs and other impediments of trading that the authors call rictions It also presents an interactive simulation model of equity market trading, TraderEx, that enables students to implement trading decisions in different market scenarios and structures. Addressing these topics shines a bright light on how a real-world financial market operates, and the simulation provides students with an experiential learning opportunity that is informative and fun. Each of the chapters is designed so that it can be used as a stand-alone module in an existing economics, finance, or information science course. Instructor resources such as discussion questions, Powerpoint slides and TraderEx exercises are available online.
Author: Jens Carsten Jackwerth
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
Author: Andreas Jobst
Publisher: International Monetary Fund
ISBN: 1475505590
Category : Business & Economics
Languages : en
Pages : 70
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Book Description
Little progress has been made so far in addressing—in a comprehensive way—the externalities caused by impact of the interconnectedness within institutions and markets on funding and market liquidity risk within financial systems. The Systemic Risk-adjusted Liquidity (SRL) model combines option pricing with market information and balance sheet data to generate a probabilistic measure of the frequency and severity of multiple entities experiencing a joint liquidity event. It links a firm’s maturity mismatch between assets and liabilities impacting the stability of its funding with those characteristics of other firms, subject to individual changes in risk profiles and common changes in market conditions. This approach can then be used (i) to quantify an individual institution’s time-varying contribution to system-wide liquidity shortfalls and (ii) to price liquidity risk within a macroprudential framework that, if used to motivate a capital charge or insurance premia, provides incentives for liquidity managers to internalize the systemic risk of their decisions. The model can also accommodate a stress testing approach for institution-specific and/or general funding shocks that generate estimates of systemic liquidity risk (and associated charges) under adverse scenarios.
Author: Jan H. Maruhn
Publisher: Walter de Gruyter
ISBN: 3110208512
Category : Mathematics
Languages : en
Pages : 210
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Book Description
Static hedge portfolios for barrier options are very sensitive with respect to changes of the volatility surface. To prevent potentially significant hedging losses this book develops a static super-replication strategy with market-typical robustness against volatility, skew and liquidity risk as well as model errors. Empirical results and various numerical examples confirm that the static superhedge successfully eliminates the risk of a changing volatility surface. Combined with associated sub-replication strategies this leads to robust price bounds for barrier options which are also relevant in the context of dynamic hedging. The mathematical techniques used to prove appropriate existence, duality and convergence results range from financial mathematics, stochastic and semi-infinite optimization, convex analysis and partial differential equations to semidefinite programming.
Author: Yakov Amihud
Publisher: Now Publishers Inc
ISBN: 1933019123
Category : Business & Economics
Languages : en
Pages : 109
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Book Description
Liquidity and Asset Prices reviews the literature that studies the relationship between liquidity and asset prices. The authors review the theoretical literature that predicts how liquidity affects a security's required return and discuss the empirical connection between the two. Liquidity and Asset Prices surveys the theory of liquidity-based asset pricing followed by the empirical evidence. The theory section proceeds from basic models with exogenous holding periods to those that incorporate additional elements of risk and endogenous holding periods. The empirical section reviews the evidence on the liquidity premium for stocks, bonds, and other financial assets.
Author: John C. Cox
Publisher: Prentice Hall
ISBN:
Category : Business & Economics
Languages : en
Pages : 518
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Book Description
Includes the first published detailed description of option exchange operations, the first published treatment using only elementary mathematics and the first step-by-step procedure for implementing the Black-Scholes formula in actual trading.
Author: Peter Tankov
Publisher: CRC Press
ISBN: 1135437947
Category : Business & Economics
Languages : en
Pages : 552
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Book Description
WINNER of a Riskbook.com Best of 2004 Book Award! During the last decade, financial models based on jump processes have acquired increasing popularity in risk management and option pricing. Much has been published on the subject, but the technical nature of most papers makes them difficult for nonspecialists to understand, and the mathematic
Author: Mark Suresh Joshi
Publisher: Cambridge University Press
ISBN: 9780521823555
Category : Business & Economics
Languages : en
Pages : 496
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Book Description
For those starting out as practitioners of mathematical finance, this is an ideal introduction. It provides the reader with a clear understanding of the intuition behind derivatives pricing, how models are implemented, and how they are used and adapted in practice. Strengths and weaknesses of different models, e.g. Black-Scholes, stochastic volatility, jump-diffusion and variance gamma, are examined. Both the theory and the implementation of the industry-standard LIBOR market model are considered in detail. Uniquely, the book includes extensive discussion of the ideas behind the models, and is even-handed in examining various approaches to the subject. Thus each pricing problem is solved using several methods. Worked examples and exercises, with answers, are provided in plenty, and computer projects are given for many problems. The author brings to this book a blend of practical experience and rigorous mathematical background, and supplies here the working knowledge needed to become a good quantitative analyst.
Author: Michael Magill
Publisher: MIT Press
ISBN: 9780262632546
Category : Business & Economics
Languages : en
Pages : 566
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Book Description
Theory of incompl. markets/M. Magill, M. Quinzii. - V.1.
