In this paper we investigate pricing of variance swaps contracts. The literature is mostly dedicated to the pricing using replication with portfolio of vanilla options. In some papers the valuation with stochastic volatility models is discussed as well. Stochastic volatility is becoming more and more interesting to the investors. Therefore we decided to perform valuation with the Heston stochastic volatility model, as well as by using replication strategy. The thesis was done at SunGard Front Arena, so for testing the replica- tion strategy Front Arena software was used. For calibration and testing of the Heston model we used MatLab.

This thesis is a collection of three essays in empirical studies on derivatives. In the first chapter, I investigate whether credit default swap spreads are affected by how the total risk is decomposed into the systematic risk and the idiosyncratic risk for a given level of the total risk. The risk composition is measured by the systematic risk proportion, defined as the proportion of the systematic variance in the total variance. I find that a firm’s systematic risk proportion has a negative and significant effect on its CDS spreads. Moreover, this empirical finding is robust to various alternative specifications and estimations. Therefore, the composition of the total risk is an important determinant of CDS spreads. In the second chapter, I estimate the illiquidity premium in the CDS spreads based on Jarrow’s illiquidity-modified Merton model using the transformed-data maximum likelihood estimation method. I find that the average model implied CDS illiquidity premium is about 15 basis points, accounting for 12% of the average level of the CDS spread. I further investigate how this parameter is affected by CDS liquidity measures such as the percentage bid-ask spread and the number of daily CDS spreads available in one month. I find that both liquidity measures are significant determinants of the model implied CDS illiquidity premium. In terms of relative importance, the bid-ask spread is more important than the number of daily CDS spreads statistically and economically. In the third chapter, I investigate the impact of the systematic risk on the volatility spread, i.e, the difference between the risk-neutral volatility and the physical volatility. I find that the systematic risk proportion of an underlying asset has a positive and significant impact on its volatility spread. The risk-neutral volatility in this study is measured with the increasingly popular approach known as the model-free risk-neutral volatility. The surprising positive systematic risk effect was first documented in Duan and Wei (2009) using the Black-Scholes implied volatility. I show that this effect is actually more prominent using the clearly better model-free risk-neutral volatility measure.

This study examines the issue of tax neutrality of the income tax treatment of credit swaps in Canada in domestic context. It analyzes the applicable tax regime consisting of rules on tax characterization, timing and tax rates through the lenses of symmetry, consistency and certainty approaches. The study argues that the Canadian tax policy focuses on achieving symmetry in income tax treatment, rather than consistency. This is because introducing consistency would contradict the fundamental principles of the Canadian law. The study finds that the current tax regime is only partially neutral because symmetry has not been achieved in respect to credit swaps entered between non-financial organizations. To enhance symmetry, the study proposes to adopt a mandatory mark-to-market basis of taxation of credit swaps for the non-financial organizations. Further, to make income tax treatment more certain, the study proposes that the CRA should issue a non-binding guidance on credit swaps.

This study examines the issue of tax neutrality of the income tax treatment of credit swaps in Canada in domestic context. It analyzes the applicable tax regime consisting of rules on tax characterization, timing and tax rates through the lenses of symmetry, consistency and certainty approaches. The study argues that the Canadian tax policy focuses on achieving symmetry in income tax treatment, rather than consistency. This is because introducing consistency would contradict the fundamental principles of the Canadian law. The study finds that the current tax regime is only partially neutral because symmetry has not been achieved in respect to credit swaps entered between non-financial organizations. To enhance symmetry, the study proposes to adopt a mandatory mark-to-market basis of taxation of credit swaps for the non-financial organizations. Further, to make income tax treatment more certain, the study proposes that the CRA should issue a non-binding guidance on credit swaps.

This thesis is a collection of three essays in empirical studies on derivatives. In the first chapter, I investigate whether credit default swap spreads are affected by how the total risk is decomposed into the systematic risk and the idiosyncratic risk for a given level of the total risk. The risk composition is measured by the systematic risk proportion, defined as the proportion of the systematic variance in the total variance. I find that a firm’s systematic risk proportion has a negative and significant effect on its CDS spreads. Moreover, this empirical finding is robust to various alternative specifications and estimations. Therefore, the composition of the total risk is an important determinant of CDS spreads. In the second chapter, I estimate the illiquidity premium in the CDS spreads based on Jarrow’s illiquidity-modified Merton model using the transformed-data maximum likelihood estimation method. I find that the average model implied CDS illiquidity premium is about 15 basis points, accounting for 12% of the average level of the CDS spread. I further investigate how this parameter is affected by CDS liquidity measures such as the percentage bid-ask spread and the number of daily CDS spreads available in one month. I find that both liquidity measures are significant determinants of the model implied CDS illiquidity premium. In terms of relative importance, the bid-ask spread is more important than the number of daily CDS spreads statistically and economically. In the third chapter, I investigate the impact of the systematic risk on the volatility spread, i.e, the difference between the risk-neutral volatility and the physical volatility. I find that the systematic risk proportion of an underlying asset has a positive and significant impact on its volatility spread. The risk-neutral volatility in this study is measured with the increasingly popular approach known as the model-free risk-neutral volatility. The surprising positive systematic risk effect was first documented in Duan and Wei (2009) using the Black-Scholes implied volatility. I show that this effect is actually more prominent using the clearly better model-free risk-neutral volatility measure.

In recent years, concerns have been raised about the real effects of credit default swaps (CDS) on the economy. Different from the hitherto accepted view that derivatives are redundant, CDS may affect the credit risk and strategic liquidity decision of the reference entities. In this dissertation, I use a unique, comprehensive sample covering 901 CDS introductions on North American corporate issuers, between June 1997 and April 2009, to address these questions. In chapter 2, I investigate whether CDS trading increases the credit risk of the reference entities. I find that the probability of both a credit rating downgrade and bankruptcy increase after the inception of CDS trading. This finding is robust to controlling for the endogeneity of CDS trading in difference-in-difference analysis, propensity score matching, and treatment regressions with instruments. In further corroboration of our basic results, I explore the mechanism behind the increased credit risk after CDS trading, and show that firms with relatively larger amounts of CDS contracts outstanding, and those with more “no restructuring” contracts, are more adversely affected by CDS trading. In chapter 3, I further investigate the effect of CDS on corporate cash holding policies. U.S. firms are holding more cash than at any time in nearly half a century. I find that CDS trading affects corporate cash holdings. Corporate cash holdings increase after the inception of CDS trading. The impact is significant after controlling for the endogeneity of CDS trading. Moreover, cash-to-assets ratios for firms with larger CDS contracts outstanding, and those with less access to financial market are more affected by CDS trading. The impact of CDS is beyond the direct effect of line of credit on cash holdings. / published_or_final_version / Economics and Finance / Doctoral / Doctor of Philosophy

Parameterized string correction decision problems investigate the possibility of transforming a given string X into a target string Y using a fixed number of edit operations, k. There are four possible edit operations: swap, delete, insert and substi- tute. In this work we consider the NP--complete STRING-TO-STRING CORREC- TION problem restricted to deletes and swaps and parameterized by the number of allowed operations. Specifically, the problem asks whether there exists a trans- formation from X into Y consisting of at most k deletes or swaps. We present a fixed parameter algorithm that runs in O(2k(k + m)), where m is the length of the destination string. Further, we present an implementation of an extended version of the algorithm that constructs the transformation sequence ! of length ay most k, given its existence. This thesis concludes with a discussion comparing the practical run times obtained from our implementation with the proposed theoretical results. Efficient string correction algorithms have applications in several areas, for example computational linguistics, error detection and correction, and computational biology. / Graduate

Thesis (M.Phil.)--Hong Kong University of Science and Technology, 2009. / Includes bibliographical references (p. 58-60).

Thesis (Ph. D.)--University of Chicago, Graduate School of Business, August 2002. / Includes bibliographical references. Also available on the Internet.

Thesis (Ph. D.)--University of Texas at Austin, 2005. / Vita. Includes bibliographical references.