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Article
Publication date: 19 October 2010

Abstract

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Managerial Finance, vol. 36 no. 12
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 28 September 2010

Abstract

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Managerial Finance, vol. 36 no. 11
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 27 September 2011

Shuangzhe Liu and Milind Sathye

Abstract

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Managerial Finance, vol. 37 no. 11
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 27 September 2011

Roger Gay

The purpose of this paper is to examine use of the Black‐Scholes (BS) risky asset model to determine choice of optimal investment term in a reinvestment chain model.

Abstract

Purpose

The purpose of this paper is to examine use of the Black‐Scholes (BS) risky asset model to determine choice of optimal investment term in a reinvestment chain model.

Design/methodology/approach

An extension of Tobin's separation theorem is used to establish a mean‐variance efficient strategy for lump sum conversion to an income stream over any fixed term; two criteria involving the BS model are then applied to determine optimal investment term in a perpetual chain of reinvestment. The first criterion selects the term to maximize the value of a call option on excess of a market portfolio accumulation over the indexed value of the original lump sum. The second criterion selects term to maximize the expected present value of this excess without the no‐arbitrage assumption.

Findings

It is found that both criteria lead to useful but different income stream funding strategies. Annual returns data for the All Ordinaries Accumulation Index for years 1900‐2009 are used for an empirical assessment of the relative usefulness of the two criteria. Empirical evidence favours use of the criterion without the no‐arbitrage assumption.

Originality/value

Mean‐variance efficiency of the lump sum conversion strategy has been described elsewhere, but it has not previously been recognized as an extension of the Tobin theorem. Determination of optimal reinvestment term in this context is new and crucial to practical application of the model. One application of universal significance is for retirees emerging from defined contribution pension schemes with lump sums to provide for retirement in the face of longevity risk.

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Article
Publication date: 27 September 2011

Fangcheng Hao and Hailiang Yang

The purpose of this paper is to provide a scenario‐based risk measure for a portfolio of European‐style derivative securities over a fixed time horizon under the regime…

Abstract

Purpose

The purpose of this paper is to provide a scenario‐based risk measure for a portfolio of European‐style derivative securities over a fixed time horizon under the regime switching Black‐Scholes economy.

Design/methodology/approach

The risk measure is constructed by using the risk‐neutral probability, the physical probability and a family of subjective probability measures. The subjective probabilities can be interpreted as risk managers or regulators' risk preferences and/or subjective beliefs.

Findings

The authors provide closed form expressions for the European option and barrier option.

Research limitations/implications

The results are difficult to apply to a portfolio with many different kinds of options.

Practical implications

The results provide some insights on risk management of portfolios with derivatives.

Originality/value

The paper presents a scenario‐based risk measure for a portfolio of European‐style derivative securities over a fixed time horizon under the regime switching Black‐Scholes economy. Risk management is the most important task for almost all financial industries, although it cannot be claimed that the method and results of this paper solve the problem, it is believed to provide some insights to the problem, albeit theoretical. For vanilla European options and barrier options, the authors obtained a closed form expression for the risk measure. The idea of this paper can be applied to some other exotic options. For portfolios containing different kinds of derivatives, the results of this paper provide some guideline and insights.

Details

Managerial Finance, vol. 37 no. 11
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 27 September 2011

Apostolos Kourtis and Raphael N. Markellos

The purpose of this paper is to study the importance of business time, and market opening/closing times and days, for American option pricing.

Abstract

Purpose

The purpose of this paper is to study the importance of business time, and market opening/closing times and days, for American option pricing.

Design/methodology/approach

A Bermudan pricing approach is employed whereby the option can be exercised only during the times and days the market is open. The authors apply the approach to the S&P 100 options market.

Findings

It was found that the potential biases that can arise from ignoring the non‐continuous operation of the market are not negligible.

Research limitations/implications

For expositional purposes, the authors assume that the price of the underlying follows a Geometric Brownian motion. This assumption could be relaxed by future research and more complex price dynamics models could be considered.

Practical implications

The findings in this paper could be used in correcting observed option prices, prior to investigating the rationality of early exercise decisions, or in measuring the size of early exercise premia.

Originality/value

This is the first study to examine the effects of business time, and market opening/closing times and days, to American option prices.

Details

Managerial Finance, vol. 37 no. 11
Type: Research Article
ISSN: 0307-4358

Keywords

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Article
Publication date: 27 September 2011

Takeaki Kariya, Fumiaki Ushiyama and Stanley R. Pliska

The purpose of this paper is to generalize the one‐factor mortgage‐backed securities (MBS)‐pricing model proposed by Kariya and Kobayashi to a three‐factor model. The…

Abstract

Purpose

The purpose of this paper is to generalize the one‐factor mortgage‐backed securities (MBS)‐pricing model proposed by Kariya and Kobayashi to a three‐factor model. The authors describe prepayment behavior due to refinancing and rising housing prices by discrete‐time, no‐arbitrage pricing theory, making an association between prepayment behavior and cash flow patterns.

Design/methodology/approach

The structure, rationality and potential for practical use of our model is demonstrated by valuing an MBS via Monte Carlo simulation and then conducting a comparative static analysis.

Findings

The proposed model is found to be effective for analysing MBS cash flow patterns, making a decision for bond investments and risk management due to prepayment.

Originality/value

While the one‐factor valuation model Kariya and Kobayashi treated is a basic framework, the generalized model presented in this paper is much more effective for analysing MBS cash flow patterns, making a decision for bond investments and risk management due to prepayment.

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Article
Publication date: 27 September 2011

Takeaki Kariya

In June of 2001, Tokyo Electric Power Company (TEPCO) and Tokyo Gas Supply Company (TGSC) made a zero‐cost risk swap contract on the average temperature of August and…

Abstract

Purpose

In June of 2001, Tokyo Electric Power Company (TEPCO) and Tokyo Gas Supply Company (TGSC) made a zero‐cost risk swap contract on the average temperature of August and September of 2001 in Tokyo for their adverse situations. This is an exchange of two options on the average temperature, by which TEPCO and TGSC can, respectively, hedge against a cold summer and a hot summer. The purpose of this paper is to develop a theoretical framework to evaluate the fairness or rationality of such a zero‐cost weather risk swap, derive some conditions to check the rationality and empirically evaluate the fairness of the above temperature risk swap between the two companies.

Design/methodology/approach

To provide a framework for analyzing weather risk swap, the authors used a statistical approach and a basic analysis is given with data and simulation.

Findings

First, the authors define the concept of full equivalence and moment equivalence of two options on a weather index and then derive some conditions for full and moment equivalences. Third, using the stochastic volatility model in Kariya et al., it is shown that the options in the TEPCO–TGSC risk swap are neither fully equivalent nor moment‐equivalent as they stand.

Originality/value

This paper originates the weather risk swap valuation problem and gives a framework to analyze and value the equivalence of a temperature risk swap. This method can be applied to various possible risk swaps for risk management.

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Article
Publication date: 27 September 2011

Chia‐lin Chang, Juan‐Ángel Jiménez‐Martín, Michael McAleer and Teodosio Pérez‐Amaral

The Basel II Accord requires that banks and other authorized deposit‐taking institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary…

Abstract

Purpose

The Basel II Accord requires that banks and other authorized deposit‐taking institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure value‐at‐risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realized losses exceed the estimated VaR. The purpose of this paper is to address the question of risk management of risk, namely VaR of VIX futures prices.

Design/methodology/approach

The authors examine how different risk management strategies performed before, during and after the 2008‐2009 global financial crisis (GFC).

Findings

The authors find that an aggressive strategy of choosing the supremum of the univariate model forecasts is preferred to the other alternatives, and is robust during the GFC.

Originality/value

The paper examines how different risk management strategies performed before, during and after the 2008‐2009 GFC, and finds that an aggressive strategy of choosing the supremum of the univariate model forecasts is preferred to the other alternatives, and is robust during the GFC.

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Article
Publication date: 27 September 2011

Robert J. Elliott, Tak Kuen Siu and Alex Badescu

The purpose of this paper is to consider a discrete‐time, Markov, regime‐switching, affine term‐structure model for valuing bonds and other interest rate securities. The…

Abstract

Purpose

The purpose of this paper is to consider a discrete‐time, Markov, regime‐switching, affine term‐structure model for valuing bonds and other interest rate securities. The proposed model incorporates the impact of structural changes in (macro)‐economic conditions on interest‐rate dynamics. The market in the proposed model is, in general, incomplete. A modified version of the Esscher transform, namely, a double Esscher transform, is used to specify a price kernel so that both market and economic risks are taken into account.

Design/methodology/approach

The market in the proposed model is, in general, incomplete. A modified version of the Esscher transform, namely, a double Esscher transform, is used to specify a price kernel so that both market and economic risks are taken into account.

Findings

The authors derive a simple way to give exponential affine forms of bond prices using backward induction. The authors also consider a continuous‐time extension of the model and derive exponential affine forms of bond prices using the concept of stochastic flows.

Originality/value

The methods and results presented in the paper are new.

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