Mathematical Aspects of Financial Markets with Frictions

Frictions are factors that hinder trading of securities in financial markets. Typical frictions include limited market depth, transaction costs, lack of infinite divisibility of securities, and taxes. Conventional models used in mathematical finance often gloss over these issues, which affect almost all financial markets, by arguing that the impact of frictions is negligible and, consequently, the frictionless models are valid approximations. This dissertation consists of three research papers, which are related to the study of the validity of such approximations in two distinct modeling problems. Models of price dynamics that are based on diffusion processes, i.e., continuous strong Markov processes, are widely used in the frictionless scenario. The first paper establishes that diffusion models can indeed be understood as approximations of price dynamics in markets with frictions. This is achieved by introducing an agent-based model of a financial market where finitely many agents trade a financial security, the price of which evolves according to price impacts generated by trades. It is shown that, if the number of agents is large, then under certain assumptions the price process of security, which is a pure-jump process, can be approximated by a one-dimensional diffusion process. In a slightly extended model, in which agents may exhibit herd behavior, the approximating diffusion model turns out to be a stochastic volatility model. Finally, it is shown that when agents' tendency to herd is strong, logarithmic returns in the approximating stochastic volatility model are heavy-tailed. The remaining papers are related to no-arbitrage criteria and superhedging in continuous-time option pricing models under small-transaction-cost asymptotics. Guasoni, Rásonyi, and Schachermayer have recently shown that, in such a setting, any financial security admits no arbitrage opportunities and there exist no feasible superhedging strategies for European call and put options written on it, as long as its price process is continuous and has the so-called conditional full support (CFS) property. Motivated by this result, CFS is established for certain stochastic integrals and a subclass of Brownian semistationary processes in the two papers. As a consequence, a wide range of possibly non-Markovian local and stochastic volatility models have the CFS property.

Pyrrolidine ring conformations in prolyl peptides from 13C spin-lattice relaxation times

A method was developed in the framework of a bistable jump model to obtain the pyrrolidine ring conformations in proline peptides from 13C spin-lattice relaxation times. Equations are presented expressing the ring torsions in terms of the 13C spin-lattice relaxation times of the ring carbons. This method was applied to 26 pyrrolidine ring systems and acceptable conformations were obtained.

Strategic Information Acquisition: Applications to Herding and Auctions

The information that the economic agents have and regard relevant to their decision making is often assumed to be exogenous in economics. It is assumed that the agents either poses or can observe the payoff relevant information without having to exert any effort to acquire it. In this thesis we relax the assumption of ex-ante fixed information structure and study what happens to the equilibrium behavior when the agents must also decide what information to acquire and when to acquire it. This thesis addresses this question in the two essays on herding and two essays on auction theory. In the first two essays, that are joint work with Klaus Kultti, we study herding models where it is costly to acquire information on the actions that the preceding agents have taken. In our model the agents have to decide both the action that they take and additionally the information that they want to acquire by observing their predecessors. We characterize the equilibrium behavior when the decision to observe preceding agents' actions is endogenous and show how the equilibrium outcome may differ from the standard model, where all preceding agents actions are assumed to be observable. In the latter part of this thesis we study two dynamic auctions: the English and the Dutch auction. We consider a situation where bidder(s) are uninformed about their valuations for the object that is put up for sale and they may acquire this information for a small cost at any point during the auction. We study the case of independent private valuations. In the third essay of the thesis we characterize the equilibrium behavior in an English auction when there are informed and uninformed bidders. We show that the informed bidder may jump bid and signal to the uninformed that he has a high valuation, thus deterring the uninformed from acquiring information and staying in the auction. The uninformed optimally acquires information once the price has passed a particular threshold and the informed has not signalled that his valuation is high. In addition, we provide an example of an information structure where the informed bidder initially waits and then makes multiple jumps. In the fourth essay of this thesis we study the Dutch auction. We consider two cases where all bidders are all initially uninformed. In the first case the information acquisition cost is the same across all bidders and in the second also the cost of information acquisition is independently distributed and private information to the bidders. We characterize a mixed strategy equilibrium in the first and a pure strategy equilibrium in the second case. In addition we provide a conjecture of an equilibrium in an asymmetric situation where there is one informed and one uninformed bidder. We compare the revenues that the first price auction and the Dutch auction generate and we find that under some circumstances the Dutch auction outperforms the first price sealed bid auction. The usual first price sealed bid auction and the Dutch auction are strategically equivalent. However, this equivalence breaks down in case information is acquired during the auction.

Responses of the Circadian Locomotor Activity Rhythm of Mus Booduga to Shifts in LD Schedules

The responses of the field mouse Mus booduga to shifts in schedules of LD cycles were monitored and the results were interpreted with the help of a PRC constructed for the same species. The results reveal that, M. booduga reentrained faster with a lesser number of transients after delay shifts than advance shifts, thus exhibiting “asymmetry effect.” A positive correlation was observed between the number of transients and the number of hours of shift. In most of the shifts, the sign of the transients (negative for delaying transients and positive for advancing transients) coincided with the direction of the shift. Interestingly, 11 and 12 h of advance shifting resulted in delaying transients. An 11-h advance shift can also be interpreted as a 13-h delay. Reentrainment through delaying transients is faster as compared to reentrainment through advancing transients. Thus, this animal might have taken a “shorter route,” as proved by the fact that an 11-h advance shift has evoked delaying transients. But a 13-h advance shift evoked only advancing transients. This prompts us to speculate that there may be a “phase jump” in M. booduga. Further, irrespective of whether L or D has been doubled in a 12-h shift, both evoked only delaying transients.

Multiferroic properties of ErMnO3

Measurements of magnetic and dielectric properties of single crystalline ErMnO3 establish the Neel and ferroelectric transition temperatures to be 77 K and 588 K respectively. The dielectric constant of ErMnO3 shows an anomalous jump at T-N. At higher temperatures, the dielectric constant undergoes a significant decrease on application of magnetic fields. The study clearly exhibits multiferroic and magnetoelectric nature of ErMnO3.

Nonlinear secondary whirl of an overhung rotor

Gravity critical speeds of rotors have hitherto been studied using linear analysis, and ascribed to rotor stiffness asymmetry. Here, we study an idealized asymmetric nonlinear overhung rotor model of Crandall and Brosens, spinning close to its gravity critical speed.Nonlinearities arise from finite displacements, and the rotor's staticlateral deflection under gravity is taken as small. Assuming small asymmetry and damping, slow modulations of whirl amplitudes are studied using the method of multiple scales. Inertia asymmetry appears only at second order. More interestingly, even without stiffness asymmetry, the gravity-induced resonance survives through geometric nonlinearities. The gravity resonant forcing does not influence the resonant mode at leading order, unlike the typical resonant oscillations. Nevertheless,the usual phenomena of resonances, namely saddle-node bifurcations, jump phenomena and hysteresis, are all observed. An unanticipated periodic solution branch is found. In the three-dimensional space oftwo modal coefficients and a detuning parameter, the full set of periodic solutions is found to be an imperfect version of three mutually intersecting curves: a straight line,a parabola and an ellipse.

A geometric approach to stationary defect solutions in one space dimension

In this manuscript, we consider the impact of a small jump-type spatial heterogeneity on the existence of stationary localized patterns in a system of partial dierential equations in one spatial dimension...

Insulator-metal transition

A theory of the insulator-metal transition in transition-metal compounds is developed in terms of the collapse of the effective energy gap which is a function of the thermally excited electron-hole pairs. This dependence is shown to arise from the hole-lattice interaction. The reaction of the lattice is found to be equivalent to generating an internal positive pressure (strain). Estimates show that the observed typical behaviour of the conductivity jump and the change of volume at the transition temperature can be explained by the present theory.

Deformation and crystallization of Zr-based amorphous alloys in homogeneous flow regime

The purpose of this study is to experimentally investigate the interaction of inelastic deformation and microstructural changes of two Zr-based bulk metallic glasses (BMGs): Zr41.25Ti13.75Cu12.5Ni10Be22.5 (commercially designated as Vitreloy 1 or Vit1) and Zr46.75Ti8.25Cu7.5Ni10Be27.5 (Vitreloy 4, Vit4). High-temperature uniaxial compression tests were performed on the two Zr alloys at various strain rates, followed by structural characterization using differential scanning calorimetry (DSC) and transmission electron microscopy (TEM). Two distinct modes of mechanically induced atomic disordering in the two alloys were observed, with Vit1 featuring clear phase separation and crystallization after deformation as observed with TEM, while Vit4 showing only structural relaxation with no crystallization. The influence of the structural changes on the mechanical behaviors of the two materials was further investigated by jump-in-strain-rate tests, and flow softening was observed in Vit4. A free volume theory was applied to explain the deformation behaviors, and the activation volumes were calculated for both alloys.

Modeling and Forecasting Implied Volatility: Implications for Trading, Pricing, and Risk Management

Modeling and forecasting of implied volatility (IV) is important to both practitioners and academics, especially in trading, pricing, hedging, and risk management activities, all of which require an accurate volatility. However, it has become challenging since the 1987 stock market crash, as implied volatilities (IVs) recovered from stock index options present two patterns: volatility smirk(skew) and volatility term-structure, if the two are examined at the same time, presents a rich implied volatility surface (IVS). This implies that the assumptions behind the Black-Scholes (1973) model do not hold empirically, as asset prices are mostly influenced by many underlying risk factors. This thesis, consists of four essays, is modeling and forecasting implied volatility in the presence of options markets’ empirical regularities. The first essay is modeling the dynamics IVS, it extends the Dumas, Fleming and Whaley (DFW) (1998) framework; for instance, using moneyness in the implied forward price and OTM put-call options on the FTSE100 index, a nonlinear optimization is used to estimate different models and thereby produce rich, smooth IVSs. Here, the constant-volatility model fails to explain the variations in the rich IVS. Next, it is found that three factors can explain about 69-88% of the variance in the IVS. Of this, on average, 56% is explained by the level factor, 15% by the term-structure factor, and the additional 7% by the jump-fear factor. The second essay proposes a quantile regression model for modeling contemporaneous asymmetric return-volatility relationship, which is the generalization of Hibbert et al. (2008) model. The results show strong negative asymmetric return-volatility relationship at various quantiles of IV distributions, it is monotonically increasing when moving from the median quantile to the uppermost quantile (i.e., 95%); therefore, OLS underestimates this relationship at upper quantiles. Additionally, the asymmetric relationship is more pronounced with the smirk (skew) adjusted volatility index measure in comparison to the old volatility index measure. Nonetheless, the volatility indices are ranked in terms of asymmetric volatility as follows: VIX, VSTOXX, VDAX, and VXN. The third essay examines the information content of the new-VDAX volatility index to forecast daily Value-at-Risk (VaR) estimates and compares its VaR forecasts with the forecasts of the Filtered Historical Simulation and RiskMetrics. All daily VaR models are then backtested from 1992-2009 using unconditional, independence, conditional coverage, and quadratic-score tests. It is found that the VDAX subsumes almost all information required for the volatility of daily VaR forecasts for a portfolio of the DAX30 index; implied-VaR models outperform all other VaR models. The fourth essay models the risk factors driving the swaption IVs. It is found that three factors can explain 94-97% of the variation in each of the EUR, USD, and GBP swaption IVs. There are significant linkages across factors, and bi-directional causality is at work between the factors implied by EUR and USD swaption IVs. Furthermore, the factors implied by EUR and USD IVs respond to each others’ shocks; however, surprisingly, GBP does not affect them. Second, the string market model calibration results show it can efficiently reproduce (or forecast) the volatility surface for each of the swaptions markets.

Unrealized expectations of jumps in volatility: An explanation to the low and time-varying predictive power of implied volatility

The low predictive power of implied volatility in forecasting the subsequently realized volatility is a well-documented empirical puzzle. As suggested by e.g. Feinstein (1989), Jackwerth and Rubinstein (1996), and Bates (1997), we test whether unrealized expectations of jumps in volatility could explain this phenomenon. Our findings show that expectations of infrequently occurring jumps in volatility are indeed priced in implied volatility. This has two important consequences. First, implied volatility is actually expected to exceed realized volatility over long periods of time only to be greatly less than realized volatility during infrequently occurring periods of very high volatility. Second, the slope coefficient in the classic forecasting regression of realized volatility on implied volatility is very sensitive to the discrepancy between ex ante expected and ex post realized jump frequencies. If the in-sample frequency of positive volatility jumps is lower than ex ante assessed by the market, the classic regression test tends to reject the hypothesis of informational efficiency even if markets are informationally effective.

A one point shock capturing kinetic scheme for hyperbolic conservation laws

We have presented a new low dissipative kinetic scheme based on a modified Courant Splitting of the molecular velocity through a parameter φ. Conditions for the split fluxes derived based on equilibrium determine φ for a one point shock. It turns out that φ is a function of the Left and Right states to the shock and that these states should satisfy the Rankine-Hugoniot Jump condition. Hence φ is utilized in regions where the gradients are sufficiently high, and is switched to unity in smooth regions. Numerical results confirm a discrete shock structure with a single interior point when the shock is aligned with the grid.

Adhesion-Induced Instability in Asperities

Adhesive forces between two approaching asperities will deform the asperities, and under certain conditions this will result in a sudden runaway deformations leading to a jump-to-contact instability. We present finite element-based numerical studies on adhesion-induced deformation and instability in asperities. We consider the adhesive force acting on an asperity, when it is brought near a rigid half-space, due to van der Waals interaction between the asperity and the half-space. The adhesive force is considered to be distributed over the volume of the asperity (body force), thus resulting in more realistic simulations for the length scales considered. Iteration scheme based on a ``residual stress update'' algorithm is used to capture the effect of deformation on the adhesion force, and thereby the equilibrium configuration and the corresponding force. The numerical results are compared with the previous approximate analytical solutions for adhesion force, deformation of the asperity and adhesion-induced mechanical instability (jump-to-contact). It is observed that the instability can occur at separations much higher,and could possibly explain the higher value of instability separation observed in experiments. The stresses in asperities, particularly in case of small ones, are found to be high enough to cause yielding before jump -to-contact. The effect of roughness is considered by modeling a spherical protrusion on the hemispherical asperity.This small-scale roughness at the tip of the asperities is found to control the deformation behavior at small separations, and hence are important in determining the friction and wear due to the jump-to-contact instability.

Field induced spin reorientation transition in epitaxial La0.5Sr0.5CoO3 films

Strained epitaxial La0.5Sr0.5CoO3 films are grown on LaAlO3 substrate. Structural, electrical,and magnetic measurements were carried out. Out of plane lattice parameter of the film undergoes compressive strain and the coercivity is enhanced. The zero field cooled (ZFC) magnetization curve for a field applied parallel to the film plane shows a jump, which suggests a spin reorientation transition (SRT), while ZFC magnetization for a field applied perpendicular to the film plane is featureless. This jump in magnetization is shifted to higher temperatures when the magnetic field is reduced. The SRT is attributed to the strain in the film. (C) 2010 Elsevier B.V. All rights reserved.

On the admittance of lipid bilayer membranes: Part I. Membrane-permeable ions

The modular formalism of Rangarajan [J. Electroanal. Chem., 55 (1974) 297] has been applied to the admittance of lipid bilayer membranes. The method leads to equations which clearly show the interrelations between the various partial processes involved in ion transport, and which allow examination of model assumptions without the need for a complete rederivation of the membrane admittance. Explicit expressions are given for both the continuum and single jump models. The former includes the ionic displacement component, important mostly at high frequencies.