For example, if we agree to trade the share at some future date, we would take all the expected dividends over that period out of the future price since we would not receive these when trading the share on that future date. Undeclared dividends are based on dividend assumptions which may prove to be incorrect. To remove this dividend risk the JSE has created dividend neutral single-stock futures which removes this assumption risk. For more information on these contracts, please see the section on Dividend Derivatives. SSFs offer investors the opportunity to enhance the performance of their equity portfolios, protect their investments against adverse price movements and cheaply diversify risk.

Speculators hoping to make a profit on short term movements in the futures contract price, asset managers, hedge fund managers, arbitrageurs and retail investors seeking portfolio diversification and hedging opportunities in particular should consider this product. Following mitigation of short-sale constraints from the first two events, high idiosyncratic volatility stocks underperform low volatility stocks in the short and long run, and are associated with higher abnormal trading volume.

We then describe a parametric model of the implied volatility surface for options with a term of up to two years. We show that almost all of the variation in the implied volatility surface can be explained by the VIX index and one or two other uncorrelated factors. In order to use an option pricing model for dynamic hedging an investor will have to calibrate it to a cross-section of option prices. Microstructural noise in option prices results in a set of indistinguishable parametrizations which may give rise to different hedging errors.

In our simulation study for the Heston model, we identify the parameters most important for hedging and show which set of strikes and time to maturity is relevant for the identification of certain parameters. However, these instruments also give banks an opaque means to sever links to their borrowers, thus reducing lender incentives to screen and monitor.

In this paper, we evaluate the effect that the onset of CDS trading has on the spreads that underlying firms pay at issue when they seek funding in the corporate bond and syndicated loan markets. We report on the adequacy of using Sato processes to value equity structured products. In models used to price options on realized variance,the latter must be a random variable with a positive variance.

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An analysis of this variance of realized variance for Sato processes shows that these processes may be suited to option contracts on realized volatility. Nonlinear pricing principles based on hedging to acceptability are outlined for the purpose of pricing structured transactions. This paper extends GMM and information theoretic estimation to settings where the conditional moment restrictions are either uniform i.

The parameter of interest can be either a structural parameter, or a local conditional moment. This is the framework for option pricing based on both historical data on the underlying asset and cross-sectional data on derivative assets,as a consequence of the rather small traded volumes on derivatives.

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We find that higher moments are strongly related to returns, even after controlling for differences in size and book-to-market. This paper measures the contribution of the credit default swap CDS mar-ket to price discovery relative to equity and equity option markets. We provide a rigorous analysis of whether and to what extent the credit market acquires information prior to the option market, and vice versa. Our results indicate that investors absorb information revealed in the CDS market into option prices within a few days and vice versa.

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We observe a significant incremental flow of information from CDS to option markets for high-yield firms and following ad-verse earnings announcements. We construct synthetic variance swap returns from prices of traded options to investigate the pricing of systematic variance risk in the equity options market.

Cross sectional tests reveal no evidence of a negative market variance risk premium. Furthermore, we show that a class of linear factor models cannot simultaneously explain index and equity option prices. In particular, equity options appear to be underpriced relative to index options. To exploit the mispricing, we analyze an investment strategy known as dispersion trading, which is implemented by going long a portfolio of equity options, and short a portfolio of index options.



Why are we interested in calibrating a local volatility surface? It is mostly to price dependent exotic options which are not very liquid and the proper market quotes are not available. Local volatility also gives rise to some interesting relative value trading strategies. There is no single correct answer. Perhaps that is the reason why calibration is not only a science but also an art. This paper investigates the source for common variation in the portion of re-turns observed in U.

We extract a latent common component from firm specific changes in default risk premia that is orthogonal to known systematic risk factors during our sample period from to Asset pricing tests using returns on Bloomberg-NASD corporate bond indices suggest that our discovered latent changes in default risk premia DRP factor is priced in the corporate bond market.

Financial models are largely used in option pricing. These physical models capture several salient features of asset price dynamics. The pricing performance can be significantly enhanced when they are combined with nonparametric learning approaches, that empirically learn and correct pricing errors through estimating state price distributions.

In this paper, we propose a new semi-parametric method for estimating state price distributions and pricing financial derivatives. This method is based on a physical model guided non parametric approach to estimate the state price distribution of a normalized state variable, called theAutomatic Correction of Errors ACE in pricing formulae. These violations imply that a trader can improve her expected utility by engaging in a zero-net-cost trade. We allow the market to be incomplete and also imperfect by introducing transaction costs and bid-ask spreads.

Even though pre-crash option prices conform to the Black-Scholes-Merton model reasonably well, they are incorrectly priced if the distribution of the index return is estimated from time-series data even with a variety of statistical adjustments. Many believe that a bubble existed in Internet stocks in the to period, and that short-sale restrictions prevented rational investors from driving Internet stock prices to reasonable levels. In the presence of such short-sale constraints, option and stock prices could decouple during a bubble.



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Using intraday options data from the peak of the Internet bubble, we find almost no evidence that synthetic stock prices diverged from actual stock prices. Prices of equity index put options contain information on the price of systematic downward jump risk. We use a structural jump-diffusion firm value model to assess the level of credit spreads that is generated by option-implied jump risk premia.

In our compound option pricing model, an equity index option is an option on a portfolio of call options on the underlying firm values. We reexamine the role of option markets in the reversal process of stock prices following stock price declines of 10 percent or more. We find that the positive rebounds for non-optionable firms are caused by an abnormal increase in bid-ask spread on and before the large price decline date.

On the other hand, the bid-ask spreads for optionable firms decrease on and before the large price decline date. We also find an abnormal increase in open interest and volume in the option market on and before the large price decline date. This paper investigates whether the rise and fall of the Nasdaq at the turn of the century can be justified by changes in return risk, and whether investors are driven by irrational euphoria with systematic shifts in the market prices of risks e.

Based on model specification that accommodates fluctuations in both risk levels and market prices of different sources of risks, our analysis provides three new insights. The migration of financial betting to prediction market exchanges in the last 5 years has facilitated the creation of contracts that do not correspond to a security traded on a traditional exchange.

Prices of these options imply expectations of volatility over the very short term, and they can be used to construct an index that has significant incremental predictive power, even after controlling for multiple lags of realized volatility and implied volatility from longer-term options. These classes are i processes with independent returns and ii univariate Markov processes. The practice of recalibration is mimicked by only imposing minimal stability requirements on the candidate pricing models.

The main finding is that processes with independent returns are inadequate even for the purpose of fitting the cross-section and term-structure on a single day. Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. Some of the value of failing passes through to option prices: when failing is cheaper than borrowing, the relation between borrowing costs and option prices is significantly weaker.

The remaining value is profit to the market maker, and its ability to profit despite the usual competition between market makers appears to result from a cost advantage of larger market makers at failing. I study the cross-section of realized stock option returns and find an economically important source of predictability in the cross-sectional distribution of implied volatility.

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A zero-cost trading strategy that is long in straddles with a large positive forecast of the change in implied volatility and short in straddles with a large negative forecast produces an economically important and statistically significant average monthly return. The results are robust to different market conditions, to firm risk-characteristics, to various industry groupings, to options liquidity characteristics, and are not explained by linear factor models.

The coefficients of the state variables are highly significant and remarkably consistent across specifications of the pricing kernel, and across the two markets. This paper presents striking evidence that option trading changes the prices of underlying stocks.

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In particular, we show that on expiration dates the closing prices of stocks with listed options cluster at option strike prices. On each expiration date, the returns of option able stocks are altered by an average of at least We provide evidence that hedge rebalancing by option market makers and stock price manipulation by firm proprietary traders contribute to the clustering. This paper argues that firms may not issue debt in order to avoid the adverse selection cost of debt. The Securities and Exchange Commission was formed as a result of the stock market crash of Some of the causes of the crash were found to be a pre-crash speculative frenzy, artificially inflated trading activity, false and misleading information published by companies listed on the exchange, and insider trading.

We propose a dynamically consistent framework that allows joint valuation and estimation of stock options and credit default swaps written on the same reference company.