Showing papers by "Marti G. Subrahmanyam published in 2003"

Stale Prices and Strategies for Trading Mutual Funds

Abstract: We demonstrate that an institutional feature of numerous mutual funds - funds managing billions in assets - generates fund net asset values that reflect stale prices. Because investors can trade at these NAVs with limited transaction costs in many cases, obvious trading opportunities exist. These opportunities are especially prevalent in funds that buy Japanese or European equities. Simple, feasible strategies generate Sharpe ratios (excess return divided by standard deviation) that are many times greater than the Sharpe ratio of the underlying fund. We illustrate the potential of the strategy for three Vanguard Group mutual funds. A particular issue to keep in mind is that when implemented, the gains from these strategies are matched by offsetting losses incurred by buy-and-hold investors in these funds.

Market Incompleteness and Super Value Additivity: Implications for Securitization

Abstract: In an incomplete market economy, all claims cannot be priced uniquely based on arbitrage The prices of attainable claims (those that are spanned by traded claims) can be determined uniquely, whereas the prices of those that are unattainable can only be bounded We first show that tighter price bounds can be determined by considering all possible portfolios of unattainable claims for which there are bid/offer prices We provide an algorithm to establish these bounds We then examine how a price-taking agent can "package" new assets in order to take advantage of the incompleteness since the market places a premium on claims that improve its spanning In particular, we prove that a firm with a new investment opportunity can maximize its value by "stripping away" the maximal attainable portion of the cash flow, for which prices are determined uniquely, and selling the balance to investors at prices that preclude arbitrage Our framework has several applications in financial economics to problems ranging from securitization to the valuation of real options

A Multifactor Spot Rate Model for the Pricing of Interest Rate Derivatives

Abstract: We propose a multifactor model in which the spot rate, LIBOR, follows a lognormal process, with a stochastic conditional mean, under the risk-neutral measure. In addition to the spot rate factor, the second factor is related to the premium of the first futures rate over the spot LIBOR. Similarly, the third factor is related to the premium of the second futures rate over the first futures rate. We calibrate the model to the initial term structure of futures rates and to the implied volatilities of interest rate caplets. We then apply the model to price interest rate derivatives such as European-style and Bermudan-style swaptions, and yield-spread options. The model can be employed to price more complex interest rate derivatives, for example, path-dependent derivatives or multi-currency-dependent derivatives, because of its Markovian property.

A Multifactor Spot Rate Model for the Pricing of Interest Rate Derivatives

Abstract: We propose a multifactor model in which the spot rate, LIBOR, follows a lognormal process, with a stochastic conditional mean, under the risk-neutral measure. In addition to the spot rate factor, the second factor is related to the premium of the first futures rate over the spot LIBOR. Similarly, the third factor is related to the premium of the second futures rate over the first futures rate. We calibrate the model to the initial term structure of futures rates and to the implied volatilities of interest rate caplets. We then apply the model to price interest rate derivatives such as European- and Bermudan-style swaptions, and yieldspread options. The model can be employed to price more complex interest rate derivatives such as path-dependent derivatives or multi-currency-dependent derivatives because of its Markovian property.