Showing papers on "Volatility (finance) published in 1984"

The persistence of volatility and stock market fluctuations

Abstract: This paper examines the potential influence of changing volatility in stock market prices on the level of stock market prices. It demonstrates that volatility is only weakly serially correlated, implying that shocks to volatility do not persist. These shocks can therefore have only a small impact on stockmarket prices, since changes in volatility affect expected required rates of return for relatively short intervals. These findings lead us to be skeptical of recent claims that the stock market's poor performance during the 1970's can be explained by volatility-induced increases in risk premia.

The Effects on Output of Money Growth and Interest Rate Volatility in the United States

Abstract: In October 1979, the Federal Reserve began a policy of disinflation and also stopped stabilizing interest rates. Subsequently, interest rates became much more volatile. Using a methodology advanced by Barro, this paper estimates what this change in policy did to output in the United States. The paper finds that the stagnation of the U.S. economy since 1979 stemmed almost as much from increased interest rate volatility as from reduced money growth. The paper also assesses the extent to which increased volatility of money growth has contributed to stagnation. It finds no evidence of any appreciable contribution. The paper concludes that stabilizing interest rates is probably sensible monetary policy.

Alternative Duration Specifications and the Measurement of Basis Risk: Empirical Tests

Abstract: Dramatic increases in interest rate levels and volatility since the early 1970s have renewed interest in fixed-income securities and have motivated much study of the appropriate measure of risk for bonds. Many authors have expanded on Macaulay's (1938) concept of duration as a surrogate for risk measurement and have developed a variety of new measures of duration. Numerous commercial duration-based immunization programs are now available purporting to explain returns, to provide good measures of risk, and to protect fixed-income portfolios from volatile interest rates (e.g., Leibowitz 1979; Leibowitz and Weinberger 1981). This paper tests the explanatory power of a number of recently proposed duration measures. We show that despite the flood of articles and commercial programs claiming superiority for particular measures of duration, the measures studied were virtually indistinguishable empirically. In fact, none of them did much better than This paper empirically investigates seven duration measures and their role in explaining price volatility caused by interest rate movements, that is, basis risk. The data analysis does not support the important testable implications of the various durations as measures of basis risk. All seven durations fail linearity and single risk factor tests from which their advantages are supposed to derive. Fixed-income performance comparisons and immunization strategies based on these durations have not been worthwhile.

Volatility of Derived Demand in Industrial Markets and Its Management Implications

Abstract: Despite its importance, the volatility of derived demand in industrial markets has not been studied by marketing scholars. Here we present a description of how fluctuations in demand for fossil fue...

The Impact of GNMA Futures Trading on Cash Market Volatility

Abstract: Excerpt] A general conclusion that can be drawn from theoretical analyses of spot market volatility when futures markets exist is best summarized by Turnovsky [1983, p. 1364] who states "under their (theoretical studies) respective assumptions, the futures market almost certainly stabilizes the “spot price." This suggests that trading in futures contracts may originate when cash markets experience considerable volatility. Indeed, futures trading on a variety of financial instruments was initiated shortly after periods of historically high interest rates.

Modeling Deviations from Purchasing Power Parity (PPP)

Abstract: The volatility of the exchange rate under floating rates can be interpreted in terms of approaches that allow for short term price rigidity as well as in terms of models that consider the magnification effect of new information. This paper combines the two approaches into a unified framework,where the degree to which prices are rigid is determined endogenously. It is shown that the variance of percentage deviations from ppp has an upper bound,and that the relationship between the variance of deviations from ppp and the aggregate variability is not monotonic. Allowing for a short-run Phillips curve with optimal indexation, it is also demonstrated that a higher price flexibility will reduce deviations from ppp and output volatility.

The dynamics of regional capital accumulation

Abstract: This paper addresses the issue of how regions grow and decline, focusing on actual productive capacity within a region (rather than population, income, or migration). Traditional theory has emphasized the role of industrial inertia and cumulative causation in imposing stability on the spatial distribution of capital stock over time, while recent theories emanating from the catastrophe paradigm attempt to demonstrate the capacity for rapid and dramatic reversal of relative growth trends within regional systems. This paper offers an empirical analysis of capital accumulation in U.S. regions over the period 1954-1976 for total manufacturing and four 2-digit industries. Its aim is to assess the degree of stability or volatility which characterized the actual regional patterns of capital over this period. To achieve this goal, the analysis first assesses capital growth rates in different regions over time as well as the changing distribution of capital stock across regions. Second, the issue of volatility is directly addressed through the time-series modelling of regional capital formation in individual regions. It is concluded that, while considerable volatility is apparent in individual regions and industries, these changes are far from catastrophic in character. An alternative conceptualization of the regional investment process is offered which explains long-run change as the accumulation of short-run adjustments to capital.

On nonneutral relative price effects in monetarist thought: some Austrian misconceptions

Abstract: The rise in the rate of inflation during the 1970s was paralleled by a rise in interest in monetarism, which offered the means for controlling inflation. Despite the increased interest, monetarism is still often misunderstood, as Thomas M. Humphrey points out in “On Nonneutral Relative Price Effects in Monetarist Thought: Some Austrian Misconceptions.” Economists of the Austrian school have portrayed monetarism as oblivious to the effects of monetary disturbances on the real economy of output and jobs. Humphrey exposes their fallacy with selections from monetarist literature from the 19th century to the present. He shows that monetarism is actually similar to Austrian theory in stressing the relative price effects of monetary disturbances. As a result, monetarists and Austrians agree that to decrease disruptions to the real economy, monetary volatility should be minimized.

Determinants of duration and bond volatility

Abstract: z P 5 he concepts of duration and bond volatility are valuable tools. For example, duration is an essential ingredient of passive portfolio immunization strategies, and the relatively high and widely fluctuating interest rates of recent years have obviously made bond volatility a matter of concern to the active manager. We know that duration is also a direct measure of bond volatility, and when we study the factors that determine duration, we are also studying the factors that determine bond volatility. These factors are the bond's coupon rate, term to maturity, and yield to maturity. An understanding of the relationships between these three variables and bond volatility should help the portfolio manager make better decisions when implementing investment strategy. For example, it is commonly believed that the longer the term to maturity, the more volatile the bond, and also the longer its duration. This is not always the case, however. Under some circumstances, short-term bonds may be more volatile and have a longer duration than long-term bonds. Here is another example: While the relationship between bond volatility and term to maturity has received considerable attention, the impact of the level of interest rates on bond volatility has received relatively little attention. Yet, as we will see, the level of interest rates is a more important factor than term to maturity in determining bond volatility and duration for longterm bonds. Conversely, for short-term bonds, term to maturity is the most important factor affecting duration and bond volatility. THE PRICE OF A BOND

A new beta incorporating analysts' forecasts

Abstract: T he standard beta risk measure, based on historical data, is unable to account for the superior returns on small firms or for the returns on securities neglected by analysts. The superior risk-adjusted returns on small firms were first rigorously documented by Banz [1981] and Keim [1982], while the returns on neglected firms were reported by Arbel and Strebel [1982]. When we compute the standard beta, the historical return distributions are employed without modification as the best estimate of investors’ future expectations. The standard measurement of beta makes no allowance for the information contained in analysts’ forecasts, or for estimation risk in general. Thus, it gives no attention to the impact of analysts’ forecasts on investors’ expectations concerning the future volatility of returns, nor does it take account of instability in the historical return time series. These factors are not critical in the case of large, highly researched firms with relatively stable return data, where beta provides a reasonable estimate of future risk. For small neglected firms, however, the historical measurement of anticipated risk may be grossly inaccurate. We present a new beta derived from a respecified capital asset pricing model (CAPM), incorporating the information contained in analysts’ forecasts by allowing for uncertainty in the mean of the expected return distribution. The conceptual basis of the new beta is described in the next section. We then use a sample of 660 securities to test the new beta relative to the old beta in terms of its ability to 81

Valuing Financial Flexibility

Abstract: Two facts that corporations, underwriters and investors have been forced to confront are increased capital market volatility and increased complexity in the design of securities. However, these two facts, increased volatility and increased complexity, are not unrelated. Virtually all of the complexity in securities can be viewed as the inclusion of different options in a straight debt contract. Given the fact that the value of options is driven most significantly by volatility, the advantage of including options, i.e. financial flexibility, in securities has increased with increased market volatility. This would appear to explain why corporate issuers and institutional investors have shown substantial interest in securities which improve their flexibility in volatile markets. Therefore, techniques which can consistently reflect the role of volatility in the value of options or flexibility, should be of interest to issuers, underwriters, and investors.This paper summarizes the results of some research by Jones, Masonand Rosenfeld (MR), (1984), and presents some new results, which test the ability of a CCA model based on Black and Scholes' option pricingprinciples to predict the market price of callable corporate debt, andtherefore, the price of such common debt covenants as call provisions andcall protection, In addition, some numerical CCA results are reportedwhich demonstrate the impact of changing interest rate volatility on the value of call provisions and call protection.

Interest Rate Variability and Output: Further Evidence

Abstract: This paper provides a critique on “The Effects on Output of Money Growth and Interest Rate Volatility in the United States” by Paul Evans and offers alternative measures of interest rate variability as well as for money growth variability These alternative measures were then used to conduct some of the tests reported by Evans The results indicate that (1) it is not possible using Evan’s model to disentangle whether only unanticipated interest rate variability matters, (2) Evans’ results are sensitive to the measure of variability chosen, (3) one cannot reject the hypothesis that interest rate volatility did reduce output sharply and substantially between 1980-82 but interest rate volatility, in turn, rose because of an increase in the volatility of money growth and (4) in the model chosen by Evans to examine interest rate volatility effects, risk changes have dominant aggregate supply effects

Block Trading and Aggregate Stock Price Volatility

Abstract: (1984). Block Trading and Aggregate Stock Price Volatility. Financial Analysts Journal: Vol. 40, No. 2, pp. 54-60.

An Empirical Investigation into the Causes of the Failure of the Monetary Model of the Exchange Rate

Abstract: A well known characteristic of flexible exchange rates is their volatility, with result that their movement can be closely approximated by a random walk. One of the attractions of the monetary model of the exchange rate is its ability to offer an explanation of this volatility. A major drawback is that empirical tests of the exchange rate equation arising from the monetary model very often lead to rejection of the model. The blame for this is usually attributed to the breakdown of the purchasing power parity assumption. The main purpose of this paper is to attempt to provide measures of the relative importance of the likely principal causes of the failure of the monetary model. A second objective is to test the random walk hypothesis for exchange rates. The methodology employed is new and has wide application elsewhere. It involves explicitly modelling the misspecification by time series techniques. The results, which are for the sterling-United States Dollar and Deutschemark-United States Dollar exchange rates, confirm the importance of the breakdown of the PPP assumption but they also show that misspecification of the money market is equally important. Whilst a random walk model is found to provide a very good fit, it is shown that lagged information can be used to improve the explanation of the spot exchange rate and hence the random walk hypothesis can be rejected.

Valuing Financial Flexibility

Abstract: Two facts that corporations, underwriters and investors have been forced to confront are increased capital market volatility and increased complexity in the design of securities. However, these two facts, increased volatility and increased complexity, are not unrelated. Virtually all of the complexity in securities can be viewed as the inclusion of different options in a straight debt contract. Given the fact that the value of options is driven most significantly by volatility, the advantage of including options, i.e. financial flexibility, in securities has increased with increased market volatility. This would appear to explain why corporate issuers and institutional investors have shown substantial interest in securities which improve their flexibility in volatile markets. Therefore, techniques which can consistently reflect the role of volatility in the value of options or flexibility, should be of interest to issuers, underwriters, and investors.This paper summarizes the results of some research by Jones, Masonand Rosenfeld (MR), (1984), and presents some new results, which test the ability of a CCA model based on Black and Scholes' option pricingprinciples to predict the market price of callable corporate debt, andtherefore, the price of such common debt covenants as call provisions andcall protection, In addition, some numerical CCA results are reportedwhich demonstrate the impact of changing interest rate volatility on the value of call provisions and call protection.

The Complete Options Indexes

Abstract: A performance index measures the return experienced by a holder of a specific option position. A parameter index reflects the behavior of variables considered to be important determinants of option values, hence option investment performance. A value index provides a measure of option value over time. Index values will not be economically meaningful, however, unless standardization techniques are used to control for variations in such contract terms as time to expiration and the difference between the stock price and the option striking price. The Complete Options Indexes (COI) comprise value indexes for both calls and puts and a parameter index of implicit volatility. The indexes are based on standardized option series that are closely related to actual contracts trading in the marketplace. Used as inputs to investment decision-making, the COI numbers can provide valuable information. Correlations between historical values of the indexes, the riskless return, dividend yield and stock market return underscore the predominant role of stock volatility in the determination of option value. Correlations between the level of stock prices and the level of index values suggest that high stock prices are associated with high values for option premiums. Increases in stock prices tend to be accompanied by decreases in option premiums and decreases in the assessment of stock volatility.

On optimal factor proportions in a competitive firm under factor and output price uncertainty

Abstract: Most observers of economic events have noticed a considerable increase in the general volatility of prices over the last decade. An important byproduct often attributed to this increased price variability is greater uncertainty perceived by individual decisionmakers in the process of formulating intertemporal plans. This paper seeks to clarify and provide some extensions to previous theoretical work on the question of how economic agents adjust to increased price uncertainty in the context of the competitive firm. In particular, the question asked is whether the optimal choice of inputs in a competitive firm is affected by the advent of increased factor and output price uncertainty. The answer given in earlier studies such as those by Baron (1970), Batra and Ullah (1974), Leland (1972) and Sandmo (1971) is quite straightforward: If competitive-firm managers are risk-neutral profit maximizers, the optimal input mix remains unaffected by increased uncertainty, while under risk-averse managers, firms either reduce their scale of operations or adjust their input mix towards relatively greater use of less risky inputs.

Optimal Price Adjustment with Time-Dependent Costs

Abstract: The purpose of this paper is to analyze an optimal pricing rule for the case in which the costs of price adjustment are time dependent, and where those costs depend positively on the magnitude of the percentage price change By means of discrete time model, it is shown that the optimal response to the problem under consideration is to pre-set prices for each period at the end of the previous period Within the period prices will adjust if the unexpected shock exceeds a threshold level In such a case the new price is established at a level that is a weighted average of the pre-set level and of the equilibrium level that would have obtained in the absence of costs of contemporaneous price adjustment Under certain conditions, which are derived in the paper, higher volatility of unexpected inflation might reduce relative price volatility

An Early Look at the Volatility of Money and Interest Rates under CRR

Abstract: N February 2, 1984, the Federal Reserve enacted a system of contemporaneous reserve requirements (CRR) to replace the system of lagged reserve requirements (LRR) that had been in effect since September 1968. The Fed made this change in response to widespread criticism that, under a reserve target operating procedure, LRR made it more difficult to control the monetary aggregates and contributed to the volatility of money and, perhaps, interest rates. Thus, critics believed a return to CRR would reduce the volatility of money and might reduce the volatility of interest rates as well.’

The Persistence of Volatility and Stock Market Fluctuations

Abstract: This paper examines the potential influence of changing volatility in stock market prices on the level of stock market prices. It demonstrates that volatility is only weakly serially correlated, implying that shocks to volatility do not persist. These shocks can therefore have only a small impact on stockmarket prices, since changes in volatility affect expected required rates of return for relatively short intervals. These findings lead us to be skeptical of recent claims that the stock market's poor performance during the 1970's can be explained by volatility-induced increases in risk premia.

Interest rate variability and output: further evidence

Abstract: This paper provides a critique on “The Effects on Output of Money Growth and Interest Rate Volatility in the United States” by Paul Evans and offers alternative measures of interest rate variability as well as for money growth variability. These alternative measures were then used to conduct some of the tests reported by Evans. The results indicate that (1) it is not possible using Evan’s model to disentangle whether only unanticipated interest rate variability matters, (2) Evans’ results are sensitive to the measure of variability chosen, (3) one cannot reject the hypothesis that interest rate volatility did reduce output sharply and substantially between 1980-82 but interest rate volatility, in turn, rose because of an increase in the volatility of money growth and (4) in the model chosen by Evans to examine interest rate volatility effects, risk changes have dominant aggregate supply effects.

Optimal Price Adjustment with Time-Dependent Costs

Abstract: The purpose of this paper is to analyze an optimal pricing rule for the case in which the costs of price adjustment are time dependent, and where those costs depend positively on the magnitude of the percentage price change. By means of discrete time model, it is shown that the optimal response to the problem under consideration is to pre-set prices for each period at the end of the previous period. Within the period prices will adjust if the unexpected shock exceeds a threshold level. In such a case the new price is established at a level that is a weighted average of the pre-set level and of the equilibrium level that would have obtained in the absence of costs of contemporaneous price adjustment. Under certain conditions, which are derived in the paper, higher volatility of unexpected inflation might reduce relative price volatility.