This thesis proposes alternative ways to price contingent claims written on portfolios of credit instruments as well as on carbon underlying assets. On the first topic of this research we tackle the pricing of Collateralized Debt Obligations (CDOs) by introducing two different approaches through the application of respectively Johnson SB distributions and entropy optimization principles, in contrast to market standard pricing approaches based on variations of the Gaussian copula model. The relevance of this topic is in line with the events that unfolded during the “credit crunch” of mid-2007 to early 2009, when CDOs made headlines as being responsible for more than $542 billion in losses through writedowns by financial institutions. On the second topic we propose a pricing methodology for Emission Reduction Purchase Agreement (ERPA) contracts. These are instruments based on carbon as an asset class and created by the emergence of an international carbon market that followed the adoption of the Kyoto Protocol (KP) to the United Nations Framework Convention on Climate Change (UNFCCC) in December 1997. ERPAs are of vital importance to the function of KP’s market mechanisms and the carbon markets at large as they formalize transactions of emissions reduction offsets between sellers and buyers, more specifically transactions involving Certified Emission Reductions (CERs). We propose a pricing methodology based on stochastic modeling of CER volume delivery risk and carbon prices as the two main drivers underlying ERPAs, and apply it to a case study on a run-of-river hydro power CDM project activity in China.

This thesis exploits the information contained in high-frequency data to test and model the distributions of returns of financial assets and their volatility. In Chapter 1 we study the asymptotics of some common tests for normality when applied to returns standardized by noise measures of volatility based on the use of high-frequency data. Chapter 2 proposes dynamic models for conditional quantiles of daily returns and realized volatility exploiting the information contained in various components of historical volatility as well as option-implied volatility. Chapter 3 provides a comprehensive simulation-based comparison of alternative tests for jumps in asset prices in order to get a better understanding of the performance of the tests under different, empirically relevant, scenarios. Chapter 4 extends the testing procedures studies in Chapter 1 to the multivariate context and provides new empirical evidence about the validity of the mixture of normals hypothesis in foreign exchange markets. Chapter 5 studies the dynamics of the tail risk in the hedge fund industry. Finally, Chapter 6 introduces a new method for estimating large covariance matrices.

This thesis undertakes an investigation into time series at high frequency. The three main channels of information in high frequency data - irregular time intervals (durations), prices and volumes - are all explored and modelled to improve current understanding, while accounting for the long memory property, a crucial stylised fact found in the literature. In doing so, we make use of the theory of point processes, econometric techniques such as Whittle estimation and Kalman Filter forecasting, and also sophisticated computing architecture including database systems and programming languages across multiple software environments.

This study represents the first empirical piece of work on the IS-LM model which takes into account simultaneously the main criticisms levelled against the model and estimates its equations as a unified set of hypotheses. Specifically (a) by extending the model to include a price determination equation, expressing real sector variables in real terms and financial variables in nominal terms and introducing the price level in expenditure equations as well as in the money demand function, we have been able to determine the proportions in which each time nominal income changes are divided between output changes and price changes in a model in which the IS and LM parts ceased to be two independently shifting sets of relationships; and (b) by specifying price expectations as an endogenous element in the system and examining the relationship between the returns on bonds and equities, we have been able to distinguish between the nominal interest rate, which is appropriate for the demand for and supply of money, and the real interest rate which is relevant to investment decisions. Additionally we have admitted government activity, international trade and an endogenous money supply in the model, thus increasing its usefulness for the study of policy problems. The model's equations were estimated by two stage least squares and first order autoregressive errors (where necessary) and some of its dynamic properties as expressed in the appropriate impact and interim multipliers were analysed in relation to the set of empirical propositions known in the literature as monetarism. The validity of the propositions concerning the effect of monetary policy on interest rates and on real income and the price level in the short-run has been ascertained whereas propositions which refer to the long-run and imply an independence of real from monetary variables were not found to hold true. A number of other issues dealt with in this study are the possibility of the accommodation of the short-run and the long-run within the same structure, the existence of money illusion in expenditure equations both as a short-run and a long-run phenomenon, the relaxation of the assumption that the money demand function is homogeneous of the first degree in prices and nominal income, the effect of interest rate and special deposits on money supply, the introduction of a lag distribution characterised by weights alternating in sign and declining geometrically in absolute value and the estimation of a realistic series of full-employment output for use in the price equation. Finally, we have examined the multiplier effects of exogenous on endogenous variables in linear dynamic econometric models of higher than first order in which the lags of exogenous variables are extended to more than one period. A mistake in the theory of the calculation of multipliers in such models has been pointed out and the analysis and correct formulae have been provided. Furthermore, the asymptotic distribution of impact and interim multipliers has been derived for the case of a generalised linear dynamic model.

In this thesis, a Choice Experiment (CE) approach was used to estimate public 'willingness-to-pay' (WTP) for pesticide reduction in the UK. The need to determine WTP for pesticide reductions is driven by policy pressures to reduce the associated negative externalities of pesticide use. Two surveys were undertaken to examine different aspects of this policy concern. The first survey used a CE to value the public's WTP for pesticide-free food. This survey was large in scale but relatively simple in design. The second survey employed two related but separate CEs to value WTP for reductions in insecticides, herbicides and fungicides in the UK. In particular, it was designed to examine WTP with respect to 'environmental safety' and 'food safety' issues. The first survey was part of a large survey conducted 'in-home' by MORI for DEFRA. Though access to the MORI survey yielded a large number of respondents, the simplicity of the CE is a reflection of the space constraint faced. WTP for pesticide reduction was estimated by employing a 'standard' conditional logit (CL) model. An important component of this research is the use of a novel statistical approach to generate the CL to allow and measure respondents' tendency to mis-report their 'true' preferences. To facilitate estimation, Bayesian methods were used. The motivation for employing the generalised CL lies with the considerable concern expressed in the WTP literature regarding upwardly biased WTP estimates. Bayesian factors were used to assess model specification and indicate a strong preference for the generalised CL. As anticipated, many respondents (41%) reported 'false' preferences, most of which (79%) reported in favour of 'No Pesticides' food. By accounting for bias in responses, WTP estimates were downwardly revised by 35% relative to the standard CL. However, adjusting for mis-reporting reduced WTP from 149010 to only 97% for 'No Pesticides' food. The second survey was mail-delivered and included two CEs. Though a smaller sample than the first survey was obtained, both of these CEs were much more sophisticated. These CEs differentiated environmental and health concerns, by associating each with a particular commodity: bread, and a basket of fruit and vegetables, respectively. Both CEs were designed to estimate marginal WTP for insecticide, herbicide and fungicide reductions. Using Classical statistical methods, the CL specifications revealed that being female, environment- or food safety-sensitive, living as a couple, caring for dependents, and regularly purchasing organic food are factors that increase WTP for reduced-pesticide food. However, higher income, age and education seem to reduce WTP. In order to account for heterogeneity, a latent CL model (LCM) was estimated. Segments with positive payment parameters were initially observed. 111 instance of yea-saying was resolved by discarding respondents who only chose 'No Pesticides'. The LCM revealed a significant segmentation of the population in both CEs. Moreover, the LCMs yielded higher WTP estimates than CLs. WTP, expressed as percentage or the baseline price, was higher in the 'environmental safety' CE (102% and 83% for LCM and CL respectively) than in the 'food safety' CE (69% and 40% for LCM and CL respectively). Overall, the results presented in this thesis indicate that the public is willing to pay a considerable premium for food produced using less or no pesticides. Our results are reasonably similar for the two surveys conducted and the variation in econometric methods employed. Furthermore, the results are in keeping with the limited results available in the literature to date.

In this thesis I will present my PhD research work, focusing mainly on financial modelling of asset’s volatility and the pricing of contingent claims (financial derivatives), which consists of four topics: 1. Several changing volatility models are introduced and the pricing of European options is derived under these models; 2. A general local stochastic volatility model with stochastic interest rates (IR) is studied in the modelling of foreign exchange (FX) rates. The pricing of FX options under this model is examined through the use of an asymptotic expansion method, based on Watanabe-Yoshida theory. The perfect/partial hedging issues of FX options in the presence of local stochastic volatility and stochastic IRs are also considered. Finally, the impact of stochastic volatility on the pricing of FX-IR structured products (PRDCs) is examined; 3. A new method of non-biased Monte Carlo simulation for a stochastic volatility model (Heston Model) is proposed; 4. The LIBOR/swap market model with stochastic volatility and jump processes is studied, as well as the pricing of interest rate options under that model. In conclusion, some future research topics are suggested. Key words: Changing Volatility Models, Stochastic Volatility Models, Local Stochastic Volatility Models, Hedging Greeks, Jump Diffusion Models, Implied Volatility, Fourier Transform, Asymptotic Expansion, LIBOR Market Model, Monte Carlo Simulation, Saddle Point Approximation.

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The current practice in economics is to allocate resources on the basis of our preferences as they are expressed in real or hypothetical markets. Our preferences suffer from a number of problems, however, especially when we value non-market goods, such as the environment or health. An alternative way to value non-market goods is through our experiences, or subjective well-being (SWB). SWB is based on our subjective reports of we think and feel about life. This thesis shows how the values of non-market goods may differ according to whether preferences or SWB are used. There are a number of problems with using SWB as an alternative method of valuation but, overall, this thesis concludes that SWB provides a promising way of valuing non-market goods.

Studies of complex systems and agent-based models often focus on the relationship between microscopic behaviour and phenomena on a macroscopic level. Such models have applications in sociology, biology and economics. Here we study specific models in evolutionary game theory and game learning, analysing the differences between deterministic, population-level descriptions and stochastic, individual-level descriptions. We also examine the relationships between individual actions and global features in data from a financial market. Attempts to explain the emergence of altruism commonly use evolutionary game theory. Here, stochastic models can exhibit continued oscillations when the equivalent deterministic dynamics approach a fixed point. We classify the power spectra of such stochastic oscillations using an expansion of the master equation in the inverse system size. We find that the choice of update rule can have significant effects on the frequency and amplitude of these fluctuations.In light of recent experimental setups of social dilemmas to test the applicability of evolutionary theories to human players, we show that noise-induced oscillations can also be found in models of multiplayer game learning. We again perform an expansion in the noise strength to classify these oscillations analytically. We examine the effect that the parameters of the model can have on these fluctuations in both well-mixed and networked setups. We also use financial time series from the Spanish Stock Market to quantify features of the actions of individual trading firms. Examining how trades impact prices we find that the variety of individual behaviours cannot be inferred from that of the market. We test the applicability of an existing model by Bouchaud et al for reconstructing the response of the price to trades over time and show that it does not extend to describing any particular firm.

No description available.