Tracking error of exchange-traded funds: Evidence from the UK

This paper is mainly concerned with the tracking accuracy of Exchange Traded Funds (ETFs) listed on the London Stock Exchange (LSE) but also evaluates their performance and pricing efficiency. The findings show that ETFs offer virtually the same return but exhibit higher volatility than their benchmark. It seems that the pricing efficiency, which should come from the creation and redemption process, does not fully hold as equity ETFs show consistent price premiums. The tracking error of the funds is generally small and is decreasing over time. The risk of the ETF, daily price volatility and the total expense ratio explain a large part of the tracking error. Trading volume, fund size, bid-ask spread and average price premium or discount did not have an impact on the tracking error. Finally, it is concluded that market volatility and the tracking error are positively correlated.

The role of dispersion into assets allocation

Dispersion of returns has gained a lot of attention as a measure to distinguish good and bad investment opportunities time. In the following dissertation, the cross-sectional returns volatility is analyzed over a fifteen year period across the S&P100 Index composition. The main inference drawn from the data sample is that the canonical measure of dispersion is highly macro-risk driven and therefore more biased towards returns volatility rather than its correlation component.

Impact of Black-Scholes assumptions on Delta Hedging

In this work we are going to evaluate the different assumptions used in the Black- Scholes-Merton pricing model, namely log-normality of returns, continuous interest rates, inexistence of dividends and transaction costs, and the consequences of using them to hedge different options in real markets, where they often fail to verify. We are going to conduct a series of tests in simulated underlying price series, where alternatively each assumption will be violated and every option delta hedging profit and loss analysed. Ultimately we will monitor how the aggressiveness of an option payoff causes its hedging to be more vulnerable to profit and loss variations, caused by the referred assumptions.

Improving accuracy of inflation forecasts using macroeconomic information

This thesis examines the effects of macroeconomic factors on inflation level and volatility in the Euro Area to improve the accuracy of inflation forecasts with econometric modelling. Inflation aggregates for the EU as well as inflation levels of selected countries are analysed, and the difference between these inflation estimates and forecasts are documented. The research proposes alternative models depending on the focus and the scope of inflation forecasts. I find that models with a Generalized AutoRegressive Conditional Heteroskedasticity (GARCH) in mean process have better explanatory power for inflation variance compared to the regular GARCH models. The significant coefficients are different in EU countries in comparison to the aggregate EU-wide forecast of inflation. The presence of more pronounced GARCH components in certain countries with more stressed economies indicates that inflation volatility in these countries are likely to occur as a result of the stressed economy. In addition, other economies in the Euro Area are found to exhibit a relatively stable variance of inflation over time. Therefore, when analysing EU inflation one have to take into consideration the large differences on country level and focus on those one by one.

A comparative review of risk based portfolio allocations: An empirical study throughout rising yields

Since the financial crisis, risk based portfolio allocations have gained a great deal in popularity. This increase in popularity is primarily due to the fact that they make no assumptions as to the expected return of the assets in the portfolio. These portfolios implicitly put risk management at the heart of asset allocation and thus their recent appeal. This paper will serve as a comparison of four well-known risk based portfolio allocation methods; minimum variance, maximum diversification, inverse volatility and equally weighted risk contribution. Empirical backtests will be performed throughout rising interest rate periods from 1953 to 2015. Additionally, I will compare these portfolios to more simple allocation methods, such as equally weighted and a 60/40 asset-allocation mix. This paper will help to answer the question if these portfolios can survive in a rising interest rate environment.

Anatomy of the portuguese stock market risk and return in the 1977-2012 period

This paper analyses the Portuguese stock market since it reopened in 1977, with a special focus on the evolution of the statistic and stochastic characteristics of the market return throughout this 36 year period. The market return for the period of time between 1977 and 2012 (September 28th) is estimated and then compared with the return that would have been achieved with Government bonds and treasury bills, which allows us to confirm that the hierarchy of return / risk across the different financial instruments is verified. The market risk premium for this 36 year period is also estimated and a comparison with other markets is performed, suggesting that the Portuguese market’s risk has not been compensated by an adequate return. The study also examines the evolution of the Portuguese market’s volatility in the 1977-2012 period and compares it with other markets, showing the existence of extremely high peaks during the first 11 years, but indicating a downwards trend throughout the whole period under analysis. Finally, the correlation between market returns for Portugal and for other countries and the degree of integration are estimated and their evolution throughout time is assessed, leading to the conclusion that the performance of the Portuguese stock market has become increasingly correlated with major European markets – correlation with some markets close to 0.70 from 2000 onwards-, but that country-specific risk factors are still relevant.

Three essays on the psychology of investment and financial markets

Préface My thesis consists of three essays where I consider equilibrium asset prices and investment strategies when the market is likely to experience crashes and possibly sharp windfalls. Although each part is written as an independent and self contained article, the papers share a common behavioral approach in representing investors preferences regarding to extremal returns. Investors utility is defined over their relative performance rather than over their final wealth position, a method first proposed by Markowitz (1952b) and by Kahneman and Tversky (1979), that I extend to incorporate preferences over extremal outcomes. With the failure of the traditional expected utility models in reproducing the observed stylized features of financial markets, the Prospect theory of Kahneman and Tversky (1979) offered the first significant alternative to the expected utility paradigm by considering that people focus on gains and losses rather than on final positions. Under this setting, Barberis, Huang, and Santos (2000) and McQueen and Vorkink (2004) were able to build a representative agent optimization model which solution reproduced some of the observed risk premium and excess volatility. The research in behavioral finance is relatively new and its potential still to explore. The three essays composing my thesis propose to use and extend this setting to study investors behavior and investment strategies in a market where crashes and sharp windfalls are likely to occur. In the first paper, the preferences of a representative agent, relative to time varying positive and negative extremal thresholds are modelled and estimated. A new utility function that conciliates between expected utility maximization and tail-related performance measures is proposed. The model estimation shows that the representative agent preferences reveals a significant level of crash aversion and lottery-pursuit. Assuming a single risky asset economy the proposed specification is able to reproduce some of the distributional features exhibited by financial return series. The second part proposes and illustrates a preference-based asset allocation model taking into account investors crash aversion. Using the skewed t distribution, optimal allocations are characterized as a resulting tradeoff between the distribution four moments. The specification highlights the preference for odd moments and the aversion for even moments. Qualitatively, optimal portfolios are analyzed in terms of firm characteristics and in a setting that reflects real-time asset allocation, a systematic over-performance is obtained compared to the aggregate stock market. Finally, in my third article, dynamic option-based investment strategies are derived and illustrated for investors presenting downside loss aversion. The problem is solved in closed form when the stock market exhibits stochastic volatility and jumps. The specification of downside loss averse utility functions allows corresponding terminal wealth profiles to be expressed as options on the stochastic discount factor contingent on the loss aversion level. Therefore dynamic strategies reduce to the replicating portfolio using exchange traded and well selected options, and the risky stock.

Characterization of volatile organic gunshot residues in fired handgun cartridges by headspace sorptive extraction

In forensic investigation of firearm-related cases, determination of the residual amount of volatile compounds remaining inside a cartridge could be useful in estimating the time since its discharge. Published approaches are based on following the decrease of selected target compounds as a function of time by using solid phase micro-extraction (SPME). Naphthalene, as well as an unidentified decomposition product of nitrocellulose (referred to as "TEA2"), are usually employed for this purpose. However, reliability can be brought into question given their high volatility and the low reproducibility of their extracted quantities. In order to identify alternatives and therefore develop improved dating methods, an extensive study on the composition and variability of volatile residues in nine different types of cartridges was carried out. Analysis was performed using headspace sorptive extraction (HSSE), which is a more exhaustive technique compared to SPME. 166 compounds were identified (several of which for the first time), and it was observed that the final compositional characteristics of each residue were strongly dependent on its source. Variability of single identified compounds within and between different types of cartridge, as well as their evolution over time, was also studied. Many explosion products containing up to 4 aromatic rings were found to be globally present in high proportions amongst residues. 27 of them (excluding naphthalene) also presented detectable decreases during the first 24 h. Therefore, they could be used as complementary target analytes in future dating methods.

The significance of volatile antifungal metabolites produced by trichomerma harzianum biotype Th4, in green-mould disease of commercial mushroom crops /

The aggressive mushroom competitor, Trichoderma harzianum biotype Th4, produces volatile antifungal secondary metabolites both in culture and during the disease cycle in compost. Th4 cultures produced one such compound only when cultured in the presence of Agaricus bisporus mycelium or liquid medium made from compost colonised with A. bisporus. This compound has TLC and UVabsorption and characteristics indicating that it belongs to a class of pyrone antibiotics characterised from other T. harzianum biotypes. UV absorption spectra indicated this compound was not 6-pentyl-2H-pyran-one (6PAP), the volatile antifungal metabolite widely described in Th1. Furthermore, this compound was not produced by Th1 under any culture conditions. Mycelial growth of A. bisporus, Botrytis cinerea and Sclerotium cepivorum was inhibited in the presence of this compound through volatility , diffusion and direct application. This indicates that Th4 produces novel, volatile, antifungal metabolites in the presence of A. bisporus that are likely involved in green mould disease of mushroom crops.

Effect of executive compensation on firm performance

The paper finds evidence that the equity-based CEO pay is positively related to firm performance and risk-taking. Both stock price and operating performance as well as firm's riskiness increase in the pay-performance sensitivities (PPS) provided by CEO stock options and stock holdings. PPS can explain stock returns better as an additional factor to the Fama-French 3-factor model. When CEOs are compensated with higher PPS, firms experience higher return on asset (ROA). The higher PPS also leads to the higher risk-taking. While CEO incentive compensation has been perceived mixed on its effectiveness, this study provides support to the equity-based CEO compensation in reducing agency conflicts between CEOs and shareholders.

Empirical Assessment of an Intertemporal Option Pricing Model with Latent variables

This paper assesses the empirical performance of an intertemporal option pricing model with latent variables which generalizes the Hull-White stochastic volatility formula. Using this generalized formula in an ad-hoc fashion to extract two implicit parameters and forecast next day S&P 500 option prices, we obtain similar pricing errors than with implied volatility alone as in the Hull-White case. When we specialize this model to an equilibrium recursive utility model, we show through simulations that option prices are more informative than stock prices about the structural parameters of the model. We also show that a simple method of moments with a panel of option prices provides good estimates of the parameters of the model. This lays the ground for an empirical assessment of this equilibrium model with S&P 500 option prices in terms of pricing errors.

ARMA Representation of Integrated and Realized Variances

This paper derives the ARMA representation of integrated and realized variances when the spot variance depends linearly on two autoregressive factors, i.e., SR SARV(2) models. This class of processes includes affine, GARCH diffusion, CEV models, as well as the eigenfunction stochastic volatility and the positive Ornstein-Uhlenbeck models. We also study the leverage effect case, the relationship between weak GARCH representation of returns and the ARMA representation of realized variances. Finally, various empirical implications of these ARMA representations are considered. We find that it is possible that some parameters of the ARMA representation are negative. Hence, the positiveness of the expected values of integrated or realized variances is not guaranteed. We also find that for some frequencies of observations, the continuous time model parameters may be weakly or not identified through the ARMA representation of realized variances.

Nonparametric estimation of the leverage effect: a trade-off between robustness and efficiency

We consider two new approaches to nonparametric estimation of the leverage effect. The first approach uses stock prices alone. The second approach uses the data on stock prices as well as a certain volatility instrument, such as the CBOE volatility index (VIX) or the Black-Scholes implied volatility. The theoretical justification for the instrument-based estimator relies on a certain invariance property, which can be exploited when high frequency data is available. The price-only estimator is more robust since it is valid under weaker assumptions. However, in the presence of a valid volatility instrument, the price-only estimator is inefficient as the instrument-based estimator has a faster rate of convergence. We consider two empirical applications, in which we study the relationship between the leverage effect and the debt-to-equity ratio, credit risk, and illiquidity.

Relativistic effects in physics and chemistry of element 105. [Part] II.

Relativistic self-consistent charge Dirac-Slater discrete variational method calculations have been done for the series of molecules MBr_5, where M = Nb, Ta, Pa, and element 105, Ha. The electronic structure data show that the trends within the group 5 pentabromides resemble those for the corresponding pentaclorides with the latter being more ionic. Estimation of the volatility of group 5 bromides has been done on the basis of the molecular orbital calculations. According to the results of the theoretical interpretation HaBr_5 seems to be more volatile than NbBr_5 and TaBr_5.