Offering a unifying theoretical perspective not readily available in any other text, this innovative guide to econometrics uses simple geometrical arguments to develop students' intuitive understanding of basic and advanced topics, emphasizing throughout the practical applications of modern theory and nonlinear techniques of estimation. One theme of the text is the use of artificial regressions for estimation, reference, and specification testing of nonlinear models, including diagnostic tests for parameter constancy, serial correlation, heteroscedasticity, and other types of mis-specification. Explaining how estimates can be obtained and tests can be carried out, the authors go beyond a mere algebraic description to one that can be easily translated into the commands of a standard econometric software package. Covering an unprecedented range of problems with a consistent emphasis on those that arise in applied work, this accessible and coherent guide to the most vital topics in econometrics today is indispensable for advanced students of econometrics and students of statistics interested in regression and related topics. It will also suit practising econometricians who want to update their skills. Flexibly designed to accommodate a variety of course levels, it offers both complete coverage of the basic material and separate chapters on areas of specialized interest.

Estimation and Inference in Econometrics

Substantial progress has been made in developing more realistic option pricing models. Empirically, however, it is not known whether and by how much each generalization improves option pricing and hedging. We fill this gap by first deriving an option model that allows volatility, interest rates and jumps to be stochastic. Using S&P 500 options, we examine several alternative models from three perspectives: (1) internal consistency of implied parameters/volatility with relevant timeseries data, (2) out-of-sample pricing, and (3) hedging. Overall, incorporating stochastic volatility and jumps is important for pricing and internal consistency. But for hedging, modeling stochastic volatility alone yields the best performance. IN THE LAST TWO DECADES, option pricing has witnessed an explosion of new

/pdf/empirical-performance-of-alternative-option-pricing-models-18wa1txytu.pdf

Empirical Performance of Alternative Option Pricing Models

This article develops a new method for inferring risk-neutral probabilities (or state-contingent prices) from the simultaneously observed prices of European options. These probabilities are then used to infer a unique fully specified recombining binomial tree that is consistent with these probabilities (and, hence, consistent with all the observed option prices). A simple backwards recursive procedure solves for the entire tree. From the standpoint of the standard binomial option pricing model, which implies a limiting risk-neutral lognormal distribution for the underlying asset, the approach here provides the natural (and probably the simplest) way to generalize to arbitrary ending risk-neutral probability distributions.

http://janroman.dhis.org/finance/Binomial%20Models/Implied%20trees.pdf

Implied Binomial Trees

The basic paradigm of asset pricing is in vibrant f lux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both risk and misvaluation. This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models.

/pdf/investor-psychology-and-asset-pricing-c95w5p60ck.pdf

Investor Psychology and Asset Pricing

An efficient method is developed for pricing American options on stochastic volatility/jumpdiffusion processes under systematic jump and volatility risk. The parameters implicit in deutsche mark (DM) options of the model and various submodels are estimated over the period 1984 to 1991 via nonlinear generalized least squares, and are tested for consistency with $/DM futures prices and the implicit volatility sample path. The stochastic volatility submodel cannot explain the "volatility smile" evidence of implicit excess kurtosis, except under parameters implausible given the time series properties of implicit volatilities. Jump fears can explain the smile, and are consistent with one 8 percent DM appreciation "outlier" observed over the period 1984 to 1991. The central empirical issues in option pricing are what distributional hypotheses are consistent with observed option prices, and whether those distributional hypotheses are consistent with the properties of the un

/pdf/jumps-and-stochastic-volatility-exchange-rate-processes-1yfupj7xl1.pdf

Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutsche Mark Options

The premiums on closed-end country funds tend to move in tandem, but do not move together with premiums on domestic closed-end funds. After controlling for foreign maket fundamentals, changes in the stock price of country funds co-move with U.S. market returns, but changes in their net asset values do not. An index of changes in country fund premiums explains cross-sectional stock returns in the U.S. market, particularly for small firms. Collectively, these findings suggest U.S. stock prices are affected by market-wide sentiments which are reflected in closed-end country fund premiums.

Closed-end Country Funds and U.S. Market Sentiment

The premiums on closed-end country funds tend to move in tandem, but do not move together with premiums on domestic closed-end funds. After controlling for foreign market fundamentals, changes in the stock price of country funds co-move with U.S. market returns, but changes in their net asset values do not. An index of changes in country fund premiums explains cross-sectional stock returns in the U.S. market. Collectively, these findings suggest U.S. stock prices are affected by market-wide sentiments which are reflected in closed-end country fund premiums.

Closed-End Country Funds and U.S. Market Sentiment, Mitsui Life Financial Research Center

This paper tests the ability of the American option pricing model proposed by Parkinson [18] or Mason [14] to explain the pricing of the foreign currency options traded on the Philadelphia Stock Exchange from February 28, 1983 to March 26, 1985. We find that the model underprices out-of-the-money options relative to at-the-money and in-the-money options. This relative underpricing is driven by an underpricing of out-of-the-money call options of short maturity. In addition, the degree of relative mispricing for most categories of options is shown to be a decreasing function of the time to maturity of the options. Longer maturity options appear to trade at similar levels of implied volatility whether they are in, at, or out of the money. Most of these biases appear consistent with the fact that the underlying spot currency rate follows a mixed jump diffusion process as described in [17].

Tests of an American Option Pricing Model on the Foreign Currency Options Market

We develop an arbitrage-free discrete time model to price American-style claims for which domestic term structure risk, foreign term structure risk, and currency risk are important This model combines a discrete version of the Heath, Jarrow, and Morton (1992) term structure model with the binomial model of Cox, Ross, and Rubinstein (1979) It converges (weakly) to the continuous time models in Amin and Jarrow (1991, 1992) The general model is "path dependent" and can be implemented with arbitrary volatility functions to value claims with maturity up to five years The model is illustrated with applications to long-dated American currency warrants and a cross-rate swap from the quanto class Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies

Discrete-Time Valuation of American Options with Stochastic Interest Rates

https://deepblue.lib.umich.edu/bitstream/handle/2027.42/27724/0000114.pdf?sequence=1

James N. Bodurtha

Papers

Closed-end Country Funds and U.S. Market Sentiment

Closed-End Country Funds and U.S. Market Sentiment, Mitsui Life Financial Research Center

Tests of an American Option Pricing Model on the Foreign Currency Options Market

Discrete-Time Valuation of American Options with Stochastic Interest Rates

Economic forces and the stock market: An international perspective