This research study investigates three new considerations for improving the performance of volatility modeling of financial returns. Two of them are related to the intraday volatility modeling and the other one is about the use of overnight information for daily volatility modeling. / About the intraday volatility modeling, the limitations and potential problems of using Andersen & Bollerslev's approach are addressed and distinct modifications are proposed to tackle the corresponding issues. The first suggestion is about the utilization of the interaction between the intraday periodicity and the heteroskedasticity while the second is about the modified normalization for the estimation of the intraday periodicity. / The proposed modifications are tested with different ARCH structures, including GARCH(1,1), FIGARCH(1,d,1) and HYGARCH(1,d,1), by using simulated data and market data. Apart from studying the 1-step-ahead out-of-sample performance, several multiple-step-ahead forecasting results are also addressed. Under the same level of model flexibility (parameterized portions), our proposed modifications always outperform the original method in both in-sample fitness and out-of-sample performance on various forecasting horizons. / On the other hand, the third suggestion is about the inclusion of overnight information for the estimation of daily volatility. This study explores the possibility of incorporating the overnight variance indirectly through the use of linearly combined daily volatility estimators. The empirical results demonstrate that the inclusion of overnight variance can produce substantial influence when the minimum-variance constraints are relaxed. Besides, the influence is revealed to be not monotonic as an increase of the overnight proportion does not necessarily produce a larger influence. / Furthermore, it is demonstrated that the inclusion of overnight variance can improve the prediction accuracy of the Chicago Board of options Exchange (CBOE) volatility indexes (VIX and VXD) under specific weight combinations. The findings contradict the common perception that overnight return does not contain useful information for daily volatility modeling.

Whether the oil futures prices curves along the time to maturity (term structure) are upward (i.e. contango) or downward (i.e. backwardation) sloping is important for both academics and practitioners. On the one hand, the shape of oil futures curve determines the gain or loss when hedgers extend the prices protection in the future by shifting from nearer-to-maturity contracts to farther-to-maturity ones. On the other hand, the upward or downward sloping oil futures curves are also more relevant for the performance of oil futures investment, which has gradually become a distinct asset class as an important complement to equities and bonds and drawn a large amount of capital. / This study first investigates the oil futures price dynamics, especially on the term structure of oil futures contracts, in a relatively long sample period from late 1980s to early the year 2010. In contrast with the traditional view on the oil futures investment, the importance of rolling yields in oil futures investing fluctuates in a significant magnitude, especially in recent years. The backwardation shape of oil futures curve is not as persistent as it was in earlier periods, and the probability of contango has increased a lot in most recent years. During the whole sample period, backwardation and contango approximately have happened at odds 50-50. / Furthennore, based on the existent possible explanations of oil futures term structure, this study provides a more fundamental view, which has a theoretical support from the theory of storage and well-suited intuitions in correspondence with reality. By using structural econometrical models, it divides oil net demand into two components: one is contributed by permanent shocks and the other is contributed by transitory shocks, and finds that only transitory component in oil net demand has a significant impact on oil futures term structure. Positive transitory shocks push oil futures curve from contango to backwardation and negative transitory shocks pull oil futures curve back to contango from backwardation. This study also applies the analysis framework to OECD and Non OECD countries, respectively, to address the rising importance of emerging markets in the dynamics of world oil prices and futures term structure. / The conclusions of this study have many implications for real investment on oil futures from several perspectives. First, the demand/supply perspective and decomposition help us understand fundamentally the structure of returns on oil futures investments, as well as their correlations with other asset class, such as equities and bonds, and perform a more efficient asset allocation. Second, this study provides a basic guideline for oil prices hedgers in both long side and short side. The fundamental view helps them optimize their hedging strategies in the sense of proper term selection. Third, this study highlights the probability that analyzing oil demand and supply dynamics accurately and timely can help us judge the changing trend of oil futures curves in advance and discover mispricing and arbitrage opportunities accordingly.

A New Look at Oligopoly| Implicit Collusion Through Portfolio Diversification

Thesis (Ph.D.)--Indiana University, Dept. of Economics, 2009. / Title from PDF t.p. (viewed on Feb. 8, 2010). Source: Dissertation Abstracts International, Volume: 70-05, Section: A, page: 1743. Adviser: Eric M. Leeper.

<p> Asset prices aggregate information and reflect market expectations about real outcomes. In this dissertation, I examine the informational content of prices and investigate the implications for forecasting returns, volatility, and the successful completion of corporate events with applications for popular hedge fund trading strategies.</p><p> The first chapter introduces a structural model for stock and option pricing in mergers and acquisitions. I show theoretically and empirically that option prices contain significant content for forecasting deal outcomes. Additionally, I employ my model to study the risks and returns of merger arbitrage strategies. Consistent with the data, my model predicts that merger arbitrage exhibits low volatility and large Sharpe ratios when deals are likely to succeed. To implement this observation, I construct the returns from a buy and hold strategy that overweights deals with a high implied probability of success. The high probability strategy nearly doubles the monthly Sharpe ratio of an equal weighted strategy that invests in all of the active deals in the economy. </p><p> The second chapter, which incorporates material from a joint paper with Yacine A&iuml;t-Sahalia and Jiangmin Xu, examines the relationship between high frequency machine-readable news and asset prices. Within the trading day, I show that positive news sentiment forecasts high returns and low volatility, and that large quantities of news forecast high volatility and high volumes. In an application of these observations, I use intraday news sentiment to improve the performance of contrarian trading strategies. Additionally, I demonstrate that intraday patterns in the arrival of news are contemporaneous with patterns in realized volatility and volume, and I document examples of large price movements that lead and lag the news.</p><p> The third chapter concludes by proposing a new test of dynamic asset pricing models whose expected returns satisfy a conditional beta relationship. The test applies recent developments from the financial econometrics literature to estimate time varying betas with high frequency data thereby providing a nonparametric alternative to traditional asset pricing tests. Empirically, I find the conditional CAPM is rejected by the data.</p>

This dissertation consists of three papers. The first assesses the ability of bivariate distribution models to explain the contemporaneous and autocorrelation between volume and volatility. GMM is used to fit first and second moments of the model to the data and analyze the model's fit. The second paper looks at the uncertainty surrounding cost recovery in regulated utilities. Stock market data is used to ascertain the market's perception about the deregulation of electricity in the United States. The third and final paper looks at the economic evidence for a stochastic opportunity set from an investor's point of view. A Bayesian investor must allocate her wealth between a risky and a risk free asset after observing market data when the model for asset returns is unknown and returns are potentially predictable.

In this paper we exploit some recent computational advances in Bayesian inference, coupled with data augmentation methods, to estimate and test continuous-time stochastic volatility models. We augment the observable data with a latent volatility process which governs the evolution of the data's volatility. The level of the latent process is estimated at finer increments than the data are observed in order to derive a consistent estimator of the variance over each time period the data are measured. The latent process follows a law of motion which has either a known transition density or an approximation to the transition density that is an explicit function of the parameters characterizing the stochastic differential equation. We analyze several models which differ with respect to both their drift and diffusion components. Our results suggest that for two size-based portfolios of U.S. common stocks, a model in which the volatility process is characterized by nonstationarity and constant elasticity of instantaneous variance (with respect to the level of the process) greater than 1 best describes the data. We show how to estimate the various models, undertake the model selection exercise, update posterior distributions of parameters and functions of interest in real time, and calculate smoothed estimates of within sample volatility and prediction of out-of-sample returns and volatility. One nice aspect of our approach is that no transformations of the data or the latent processes, such as subtracting out the mean return prior to estimation, or formulating the model in terms of the natural logarithm of volatility, are required.

Tournament incentives have been extensively analyzed, and recommended as policy, by economists and compensation consultants alike. Analysis of tournaments typically looks at the effect of tournament contracts for individuals on individual behavior in non-market settings (public good provision, team tasks, etc.). In contrast, this work investigates the effect of tournament contracts for individual agents on market performance. In particular, this work investigates the effect on asset market performance of individual contracts that reward "beating the market". To this end, both theory and laboratory experiments are employed. The theoretical prediction that the rational expectations equilibrium is destroyed by the introduction of "beat the market" contracts is overwhelmingly supported by the experimental data.

This dissertation uses samples of Initial Public Offerings (IPOs) to examine the separate effects that a capital gains tax and investor interest have on trading volume and returns. Chapter one looks at how different tax rates for long-term and short-term capital gains and losses affect trading in IPOs. Prior to the Tax Reform Act of 1986 (TRA '86), long-term capital gains were taxed at a lower rate than short-term gains, presenting investors with an opportunity to increase their after-tax return by delaying the sale of appreciated assets until after they qualified for long-term status and selling depreciated assets prior to long-term qualification. Using a sample of Initial Public Offering, I find that stocks that appreciated prior to long-term qualification exhibit increased trading volume and decreased returns just after their qualification date, while stocks that depreciated prior to long-term qualification exhibit these effects just prior to their qualification date. Chapter two explores how the previously undefined variable "investor interest" affects an IPO's trading activity. The level of investor interest in an IPO prior to its issue influences its offer price, its initial return and its initial trading volume. After issue, this interest level impacts the stock's long-term trading volume, leading to a positive relationship between an IPO's initial return and its trading volume for more than three years after issuance. Using newspaper references as a proxy for the level of interest in a firm, I find that investor interest is positively related to initial return, initial trading volume and long-term trading volume.

Despite a great deal of interest by institutional investors and others in the issue of corporate governance, there is surprisingly little empirical evidence linking governance practices with firm performance. This dissertation examines the link between corporate governance practices and firm performance, acknowledging the endogenous nature of the relationship. I begin by defining corporate governance as a set of constraints and incentives on managers and shareholders bargaining to determine how the value of the firm will be allocated. In chapter one, I examine an unbalanced panel of 1,721 firms from 1980 to 1995, which includes each firm's charter and bylaw provisions, existence of a poison pill, applicable state anti-takeover laws, and board composition data, combined with financial data from CRSP and Compustat. This chapter provides the stylized facts about corporate governance today and details how governance practices have evolved over time. It also provides an explanation as to why shareholders would be willing to adopt governance provisions that have the potential to constrain their future allocations of firm value. I document that firms adopting governance provisions requiring shareholder approval tend to out perform benchmark portfolios prior to adoption and firms adopting poison pills under perform benchmark portfolios prior to adoption. I find that firms tend to under-perform benchmark portfolios following the adoption of governance provisions that are potentially harmful to shareholders. I find no relationship between CEO age, tenure, or compensation surrounding governance changes. In chapter two, I investigate the relationship between corporate governance practices and firm performance by examining firms where the constraints imposed by the governance system are most likely to be binding, i.e., firms that have experienced significant declines in quarterly operating performance. My results suggest that firms covered by fair price charter amendments and/or state control share acquisition statutes take longer to recover from declines in operating performance. I also examine firms with significant negative shocks in quarterly earnings, and find the persistence of these shocks is greater in firms covered by a freeze out statute and the persistence is lower in firms covered by cash out statutes, findings consistent with some governance features constraining shareholder value.