It is well-known in empirical finance that virtually all asset returns, whether monthly, daily, or intraday, are heavy-tailed and, particularly for stock returns, are mildly but often significantly negatively skewed. However, the tail indices, or maximally existing moments of the returns, can differ markedly across assets. To accommodate these stylized facts when modeling the joint distribution of asset returns, an asymmetric extension of the meta-elliptical t distribution is proposed. While the likelihood is tractable, for high dimensions it will be impractical to use for estimation. To address this, a fast, two-step estimation procedure is developed, based on a saddlepoint approximation to the noncentral Student's t distribution. The model is extended to support a CCC-(I)GARCH structure and demonstrated by modeling and forecasting the return series comprising the DJIA. The techniques of shrinkage, time-varying tail dependence, and weighted likelihood are employed to further enhance the forecasting performance of the model with no added computational burden.
We present an overview of corporate-finance models where firms are subject to exogenous market frictions. These models, albeit quite simple, yield reasonable predictions regarding financing, pay-outs and default, as well as asset-pricing implications. The price to pay for the said simplicity is the need to use non-standard mathematical techniques, namely Singular and Impulse Stochastic Control. We explore the cases where a firm with fixed expected profitability has access to costly equity issuance as a refinancing possibility, and that where issuance is infinitely costly. We also present a model of bank leverage.
We study capital requirements when the bank's econometric model only approximately describes the dynamics of portfolio returns—which is virtually always the case in practice. We derive a simple formula for capital requirements based on a first-order Taylor expansion of the Value at Risk around a ‘model confidence’ parameter. This formula allows to reflect the bank's confidence in the econometric model into capital requirements in a theoretically consistent manner. Numerical and empirical applications show that our formula provides valuable information for quantifying capital requirements under model risk.
We present a software system to create and implement internal markets in organizations that want to limit the CO2 emissions or the use of scarce resources by their employees. This system can be applied to domains such as business travel by distributing a limited number of permits for business travel-related CO2 emissions at the beginning of a period and then allowing the permits to be traded inside the organization. The system calculates the CO2 emissions caused by planned trips and provides the market mechanisms to trade the permits. The approach can be generalized from emission permits to any scarce good that is assigned by the management to units or individual members of the organization, such as parking spaces. Both cases are described by way of detailed examples.
Early regulator interventions into problem banks is one of the key suggestions of Basel Committee on Banking Supervision. However, no guidance is given on their design. To fill this gap, we outline an incentive-based preventive supervision strategy that eliminates bad asset management in banks. Two supervision techniques are combined: temporary regulatory administration and random audits. Our design ensures good management without excessive supervision costs, through a gradual adjustment of supervision efforts to the bank's financial health. We also allow random audits to be delegated to an independent audit agency and show how to induce agency compliance with regulatory instructions in the least costly way.
This paper investigates the motives for financial complexity by focusing on a large market of investment products exclusively targeted to households. We develop a robust measure of complexity by performing a text analysis of the term sheets of 55,000 retail structured products issued in 17 European countries since 2002. We first find that the complexity of structured products has significantly increased over the period 2002-2010. Second, calculating the fair value of a subsample of products, we show that relatively more complex products have higher markups. Third, the headline rate offered by a product is an increasing function of its complexity. Fourth, distributors targeting low-income investors, such as savings banks, offer relatively more complex products. Fifth, competition amplifies rather than mitigates the migration towards higher complexity. These findings are diffcult to fully reconcile with a completing market motive for financial complexity, while being more consistent with banks catering to yield seeking investors, or developing obfuscation strategies.
