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Friday, February 3

3rd Feb - Back to School

Back to School is back after a long break. For the bedroom quants, Bloomberg's decision to put out the API for free is probably good news. Give or take couple of months, perhaps there will be interesting stuff on sourceforge and the like.

Open Market Data InitiativeBloomberg
BB opens up it’s BLPAPI to anyone without cost or restrictions – data sold separately. Very nice for developers.

People of Quant ResearchQuantivity
Old post: quants by topics, home pages and publications

Why is price discovery in credit default swap markets news-specific? Bank of Finland (pdf)
We analyse daily lead-lag patterns in US equity and credit default swap (CDS) returns. We first document that equity returns robustly lead CDS returns. However, we find that the CDS-lag is due to common (and not firm-specific) news and arises predominantly in response to positive (instead of negative) equity market news. 

Stock Return Predictability of Cross-Market Deviations in Option Prices and Credit Default Swap Spreads SSRN
Cross-market deviations in (deep out-of-the-money) equity put option prices and credit default swap spreads of the same firm are temporary and predict future movements in the put options and credit default swaps (Carr and Wu, 2011). We document that large cross-market deviations also strongly relate to future equity prices of the reference firm. The paths of put option and equity prices are consistent with the perceptions implicit in the credit default swap history. Informed trading in credit default swaps partly explains this result. Our evidence also suggests that capital structure arbitrage activity caters for a legitimate alternative explanation.

Option-Implied Measures of Equity Risk SSRN
We establish a set of assumptions needed to construct a beta estimate from option-implied return moments using equity and index options. This beta can be computed using only option data on a single day. It is therefore potentially able to reflect sudden changes in the structure of the underlying company.

Measuring Equity Risk with Option-Implied Correlations SSRN
We use forward-looking information contained in option prices to estimate option-implied correlations and to construct an option-implied predictor of factor betas. With our implied market betas we find a monotonically increasing relation between risk, measured by beta, and return, not detectable with standard rolling window betas.

CAPM with Option-Implied Betas: Another Rescue Attempt SSRN
In 'good' states of the economy the classical CAPM with just the market factor is able to explain the cross-section of expected returns very well, while in 'bad' states firm characteristics like size and book-to-market become relevant. Our estimated probabilities for good and bad states are furthermore able to predict the market risk premium one period into the future.

Option Prices Leading Equity Prices: Do Option Traders Have an Information AdvantageSSRN
We find that the option measures immediately before these events have higher predictive ability for short-term event returns than they do in a more dated window or before a randomly selected pseudo-event. We also find that option measures have predictive ability after information events. However, this predictive ability holds only for unscheduled corporate announcements, which suggests that, relative to equity traders, option traders have superior ability to process less anticipated information.

Research Review 12-Jan: Austerity EconomicsThe Capital Spectator
Quick summaries of eight papers, some with historical focus: The "Austerity Myth": Gain without Pain? · Is the Recovery Sustainable? · Austerity and Anarchy: Budget Cuts and Social Unrest in Europe, 1919-2008 · Is Ireland Really the Role Model for Austerity? · Expansionary Austerity New International Evidence · Fiscal Policy in an Era of Austerity · Let Them Eat Cake: Socio-Economic Rights in an Age of Austerity · Eurozone Sovereign Debt Crisis

The Scapegoat Theory of exchange rates: the first testsECB (pdf)
This theory suggests that market participants may at times attach significantly more weight to individual economic fundamentals to rationalize the pricing of currencies, which are partly driven by unobservable shocks… empirical evidence that strongly supports the empirical implications of the scapegoat theory of exchange rates, with the resulting models explaining a large fraction of the variation and directional changes in exchange rates.

Safe haven, credit rating agencies and the spread of fever from Greece, Ireland and PortugalECB (pdf)
Specifically, higher risk aversion has increased the demand for the Bund and this is behind the pricing of all euro area spreads, including those for Austria, Finland and the Netherlands. Country-specific credit ratings have played a key role in the developments of the spreads for Greece, Ireland, Portugal and Spain. Finally, the rating downgrade in Greece has contributed to developments in spreads of countries with weaker fiscal fundamentals: Ireland, Portugal, Italy, Spain, Belgium and France.

Are Rating Agencies Powerful? An Investigation into the Impact and Accuracy of Sovereign RatingsIMF
Rating stability failures suggest incorporating resilience to stress scenarios. Also more regulation, transparency

Systematic Risk and the Cross-Section of Hedge Fund ReturnsSSRN
Contrary to the popular understanding that hedge funds are 'market neutral' we find that systematic risk is a highly significant factor explaining the dispersion of cross-sectional returns while at the same time measures of residual risk and tail risk seem to have little explanatory power.

The Truth About Hedge Fund
The hedge fund industry is seriously short on how it treats the subject of risk. The industry has been confusing investors by defining risk poorly and applying it post-facto to returns.

Measuring market liquidity: An introductory surveyarXiv
This paper provides a critical review of the frameworks currently available for modelling and estimating the market liquidity of assets. We consider definitions that stress the role of the bid-ask spread and the estimation of its components that arise from alternative sources of market friction. In this case, intra-daily measures of liquidity appear relevant for capturing the core features of a market, and for their ability to describe the arrival of new information to market participants.

Research Review 5-Jan: The Role Of Risk In Portfolio DesignThe Capital Spectator
Quick summaries of five papers, couple of them from practicioners.

Macrofinancial Modeling at Central Banks: Recent Developments and Future DirectionsIMF
This paper surveys dynamic stochastic general equilibrium models with financial frictions in use by central banks and discusses priorities for future development of such models for the purpose of monetary and financial stability analysis. It highlights the need to develop macrofinancial models which allow analysis of the macroeconomic effects of macroprudential policy tools and to evaluate elements of the Basel III reforms as a priority. The paper also reviews the main approaches to introducing financial frictions into general equilibrium models.

Skewness Preference and Kurtosis Aversion: Higher-Order Stochastic-Dominance Portfolio Efficiency Tests SSRN
An application shows that the stock market portfolio is inefficient relative to ten size-decile stock portfolios and riskless Treasury bills, and that skewness and kurtosis only increase the level of inefficiency, as broad diversification does more to destroy upside potential than to reduce downside risk.

Forecasting with Internet Search DataN.Y. FED
Internet search counts can also predict some financial market data releases, as well as future price movements in some financial markets.