David P. Simon

The Nasdaq Volatility Index During and After the Bubble

The VIX index of implied volatilities for OEX index options was introduced in the early 1990s and is widely followed as an investor “fear index.” This article examines the VXN, a similar volatility index for Nasdaq 100 options, over a period that includes both the inflation of the Internet “bubble” and its bursting. If the VXN is the market’s best estimate of the future volatility of the Nasdaq 100 index, it should be an unbiased forecast of subsequent realized volatility. But if the VXN represents a “fear index,” it will reflect variations in investors’ emotions, for example rising after a sharp market drop to reflect heightened concern and an increase in investors’ demand to buy put options. It may also be influenced by technical indicators of market direction. Simon finds that even after correcting for the effect of a little-known built-in bias in the way it is constructed, the VXN averages about 7-1/2 percentage points higher than subsequent realized volatility. It also shows a strong asymmetrical response to positive and negative index returns, as has been found in other implied volatility studies. A GARCH model fitted to the returns on the actual index also reveals an asymmetrical response of volatility to returns, but much smaller than for the VXN. The evidence suggests that implied volatilities from options on the Nasdaq 100 index reflect the stochastic properties of the index itself, but they also show behavior that appears to be more closely related to investor sentiment.

Exchange risk surprises in international portfolios

44 T his paper will show, perhaps startlingly, s

Markups, quantity risk, and bidding strategies at treasury coupon auctions

2 that some foreign stock market indexes were more, and none was less, exposed to exchange risk than foreign bonds between 1976 and 1979; that their exposures have generally risen since October 1979 compared to the earlier period; and that the power of portfolio diversification to reduce exposure to any given exchange rate may recently have fallen. Enroute, we offer a practical method for measuring portfolio exchange risk exposures. The possibility that these exposures to exchange risk should be hedged may be important. The vehicle for reaching these results is a new way of defining exchange risk exposure. Until now, this has been the province of accounting conventions. Here we take a financial markets approach that is applicable to stock and bond price data. Following Adler and Dumas ([l] and [3]), we define exposure as a (set of) regression coefficient(s) to be estimated in the same way as beta, the ubiquitous relative-risk measure employed in domestic portfolio analysis. This definition has the desirable property of being theoretically correct for investors who aim to hold mean-variance efficient portfolios and whose hedging instruments consist of forward and futures contracts. It has the further dual virtue of being implementable and, as we shall note, of leading to a natural way to decompose investment returns into their dollar and foreign currency components. The paper is organized as a sequence of several short sections. We first discuss the definition of cur\D rency risk exposure, derived in Adler and 1)umas ([3; appendix]), and its connection to hedging. The next section surveys the empirical procedurles and describes the data. The three following sections present, respectively, the results of estimating the exposures of foreign bonds, of individual-country stock indexes, and of diversified portfolios of stocks. We then compare and contrast the regression-based approach to estimating hedge ratios (i.e. exposures) with the alternative, dynamic hedge ratios that ernerge from continuous-time pricing models. The final section draws the implications of the results for portfolio management and draws attention to the special role of fixed-income portfolios in this connection.

THE TREASURY'S EXPERIMENT WITH SINGLE-PRICE AUCTIONS IN THE MID-1970S: WINNER'S OR TAXPAYER'S CURSE?

Abstract This study uses intraday when-issued rate quotes to examine the rewards and risks of the Treasury coupon auctions for bidders who face different tradeoffs between the winners curse and quantity risk. The data indicate that markups of auction average rates over bid when-issued rates at auction times average 3/8 basis point. I also find that when-issued rates react as strongly to bidding aggressiveness at auctions before the auction results are announced as theydo afterward, and that quantity risk is as important as the winners curse.

Segmentation in the Treasury Bill Market: Evidence from Cash Management Bills

This study examines the Treasurys experiment with single-price bond auctions in the mid-1970s and finds that, controlling for factors unrelated to auction technique, markups of auction average rates over when-issued rates shortly after auctions were a statistically significant seven to eight basis points higher at single-price auctions than at discriminating-price auctions. These results suggest that single-price auctions raised Treasury borrowing costs by roughly 3/4 percent of the issuing price of auctioned securities. Copyright 1994 by MIT Press.

Expectations and Risk in the Treasury Bill Market: An Instrumental Variables Approach

This paper examines cash management bill announcements in an event study framework and finds that segmentation in the Treasury bill market is widespread and not limited to bills maturing across month-ends. Announcements of cash management bills, which represent unexpected additional supplies of outstanding Treasury bills, cause the yields on these bills to rise significantly relative to yields on adjacent maturity bills. This paper also finds, consistent with other studies, that segmentation is greater at the short end of the bill market.

A Conditional Assessment of the Relationships Between the Major World Bond Markets

This paper examines rational expectations in the Treasury bill market from 1961 to 1988 with a risk premium specified to be proportional to the volatility of excess returns using instrumental variables. From 1961 to 1972 and from 1972 to 1979, rational expectations cannot be rejected, and both the predictive power of the yield curve and the risk premium are highly significant. By contrast, with just a constant risk premium and with a risk premium proxied by moving averages of absolute interest rate changes, rational expectations are rejected for each subperiod, and the yield curve has significant predictive information only from 1972 to 1979.

Further evidence on segmentation in the treasury bill market

This paper uses a bivariate GARCH framework to examine the lead-lag relations and the conditional correlations between 10-year US government bond returns and their counterparts from the UK, Germany, and Japan. We find that while mean and volatility spillovers exist between the major international bond markets, they are much weaker than those between equity markets. The results also indicate that the correlations between the US and other major bond market returns are time varying and are driven by changing macroeconomic and market conditions. However, in contrast to the finding that the benefits of international diversification in equity markets evaporate during high-stress periods, we find that the benefits of diversification across major government bond markets do not decrease during periods of extremely high bond market volatility or following extremely negative US and foreign bond returns.

Benefits of International Bond Diversification

Abstract This paper shows that differences in supplies of 13- and 12-week Treasury bills have statistically significant and economically meaningful effects on their yield differentials from January 1985 through October 1991, controlling for the general slope of the Treasury bill yield curve, the tendency of bills maturing at month-ends to have lower yields and the tendency of bills whose supply is augmented by cash management bills to have higher yields. The finding that market participants do not arbitrage away yield differentials that owe to differences in supplies indicates that demand curves for individual bills are downward sloping and that segmentation in the Treasury bill market is more pervasive than previously documented.

The soybean crush spread: Empirical evidence and trading strategies

Despite suggestions that diversification benefits have fallen in the recent decade, currency-hedged bonds provided U.S. investors significant diversification benefits over January 1992-September 2002. U.S. bond returns have become increasingly correlated with U.K. and German bond returns, but correlations have declined with Japanese bonds. The changing correlations are consistent with more synchronized business cycles, but correlations have not become high enough to threaten the gains from diversification. Nor are gains on a currency-hedged basis diminished during periods of weakness or increased volatility in U.S. or foreign bond markets. Risk-reward trade-offs for each bond market vary in a predictable manner, which underscores the potential benefits of international bond investing.