Model Uncertainty and Pricing Performance in Option Valuation

E-print/Working paper (2018)

The objective of this paper is to evaluate option pricing model performance at the cross sectional level. For this purpose, we propose a statistical framework, in which we in particular account for the ... [more ▼]

The objective of this paper is to evaluate option pricing model performance at the cross sectional level. For this purpose, we propose a statistical framework, in which we in particular account for the uncertainty associated with the reported pricing performance. Instead of a single figure, we determine an entire probability distribution function for the loss function that is used to measure option pricing model performance. This methodology enables us to visualize the effect of parameter uncertainty on the reported pricing performance. Using a data driven approach, we confirm previous evidence that standard volatility models with clustering and leverage effects are sufficient for the option pricing purpose. In addition, we demonstrate that there is short-term persistence but long-term heterogeneity in cross-sectional option pricing information. This finding has two important implications. First, it justifies the practitioner’s routine to refrain from time series approaches, and instead estimate option pricing models on a cross-section by cross-section basis. Second, the long term heterogeneity in option prices pinpoints the importance of measuring, comparing and testing option pricing model for each cross-section separately. To our knowledge no statistical testing framework has been applied to a single cross-section of option prices before. We propose a methodology that addresses this need. The proposed framework can be applied to a broad set of models and data. In the empirical part of the paper, we show by means of example, an application that uses a discrete time volatility model on S&P 500 European options. [less ▲]

Islamic Banking and Economic Growth: New Evidence

E-print/Working paper (2018)

While extensive work has shown that conventional banking development is generally conducive to economic growth, there are only a limited number of studies that investigate the impact of Islamic banking ... [more ▼]

While extensive work has shown that conventional banking development is generally conducive to economic growth, there are only a limited number of studies that investigate the impact of Islamic banking. Importantly, the literature on conventional banking claims that a reverse causality from economy performance to banking may exists, but existing studies on Islamic banking fail to address this potential endogeneity problem. This paper tackles this problem and explores the relationship between Islamic banking development and economic performance in a sample of 32 developed and developing countries based on data spanning the 2000 to 2016 period. The findings show that, although Islamic banks are considered small relative to the total size of the financial sector, Islamic banking is positively correlated with economic growth even after controlling for financial structure, macroeconomic factors and other variables. The outcome is robust across different econometric specifications like pooling OLS, fixed effects, panel data with over-identified GMM, and dynamic difference GMM. The results are confirmed on two different indicators of Islamic banking and hold for different time periods. [less ▲]

Asset Pricing Implications of Good Governance

E-print/Working paper (2018)

Some of the world’s poorest countries have demonstrated that political leadership and practical policies make a difference. Good governance could help to strengthen accountability, enhance participation ... [more ▼]

Some of the world’s poorest countries have demonstrated that political leadership and practical policies make a difference. Good governance could help to strengthen accountability, enhance participation and break down inequalities. Furthermore, a country’s quality of government has a positive effect on the development of its financial market and equity returns. In particular, it lowers equity volatility and, therefore, the costs of equity financing, which further helps to reduce inequalities. While price jumps are prevalent in stock markets all over the world, previous literature provides little guidance about the international nature of jumps and its relationship with country characteristics. Jumps are found to be far less systematic than the smooth (non-jump) component of country price indexes. Hence, if jumps are more idiosyncratic, governance should primarily affect the jump risk component of stock market volatility. This is good news for international investors, because diversification provides insurance against jumps. Relying on an equilibrium asset-pricing model in an economy under jump diffusion, I decompose the moments of the returns of international stock markets into a diffusive (systematic) risk and a (idiosyncratic) jump risk part. Using stock market data for a balanced panel of 52 countries, my results suggest that risk governance is an important determinant of (idiosyncratic) jump risk. Stock markets in poorly governed countries are characterized by higher volatility and more negative return asymmetry, primarily driven by the higher jump risk. Among the different governance indicators analyzed, the regulatory quality, the government effectiveness and the control of corruption appear to be most important. Results are robust to the inclusion of various controls for other country- or market-specific characteristics. My results have important policy implications. [less ▲]

EBC network, Workshop Organizer

Scientific Conference (2018, June 12)

The Impact of Feedback Trading on Option Prices

Scientific Conference (2018, April 05)

Big Moves of Mutual Funds

E-print/Working paper (2018)

Does Oil and Gold Price Uncertainty matter for the Stock Market?

in Journal of Empirical Finance (2017), 44(-), 270-285

Risk Aversion, Sentiment and the Cross-Section of Stock Returns

Presentation (2017, November 29)

Risk Aversion, Sentiment and the Cross-Section of Stock Returns

Presentation (2017, October 13)

Risk Aversion, Sentiment and the Cross-Section of Stock Returns

Scientific Conference (2017, August 23)