Francis In

The Hedge Ratio and the Empirical Relationship between the Stock and Futures Markets: A New Approach Using Wavelet Analysis

This paper examines the relationship between the stock and futures markets in terms of lead-lag relationship, correlation, and the hedge ratio using wavelet analysis. Empirical results show that (1) there is a feedback relationship between the stock and futures markets regardless of time scales, (2) wavelet correlation between two markets varies over investment horizons but remains very high, and (3) hedge ratio and the effectiveness of hedging strategies increase as the wavelet time scale increases. Simulation for utility comparisons shows that hedging effectiveness depends not only on the time scale but also on the risk aversion coefficient of an individual investor.

The influence of foreign stock markets and macroeconomic news announcements on Australian financial markets

Abstract This paper examines the impact of the major stock markets (US, UK and Japan) and of the domestic and US macroeconomic news announcements on Australias financial markets. It also investigates the dynamic interaction between the Australian futures market and the stock market, using a bivariate GJR–GARCH model. Our results indicate that the movements of these three major foreign stock markets significantly influence the Australian futures and stock markets. Some US and Australian macroeconomic news has a significant effect on the first and second moments of Australian financial markets. The data confirms that the futures market leads the stock market.

Multihorizon Sharpe Ratios

Wavelet analysis represents a new approach to investigating the empirical relationship between the Sharpe ratio and the investment horizon for portfolios of small stocks, large stocks, and intermediate–term and long–term bonds. A wavelet multiscale approach decomposes a given time series on a scale–by–scale basis. Empirical results indicate that the wavelet variance declines as the wavelet scale increases, implying that an investor with a short investment horizon must respond to every fluctuation in realized returns, while an investor with a much longer horizon faces much less significant long–run risk associated with unknown expected returns. The long scale Sharpe ratio is much higher than the short scale, implying that the Sharpe ratio is not time–consistent. Finally, stock portfolios have higher Sharpe ratios than bond portfolios, except in certain–length periods, indicating that evaluation of the performance of stock and bond portfolios should account for investment horizon.

A Longer Look at the Asymmetric Dependence between Hedge Funds and the Equity Market

This paper reexamines, at a range of investment horizons, the asymmetric dependence between hedge fund returns and market returns. Given the current availability of hedge fund data, the joint distribution of longer-horizon returns is extracted from the dynamics of monthly returns using the filtered historical simulation; we then apply the method based on copula theory to uncover the dependence structure therein. While the direction of asymmetry remains unchanged, the magnitude of asymmetry is attenuated considerably as the investment horizon increases. Similar horizon effects also occur on the tail dependence. Our findings suggest that nonlinearity in hedge fund exposure to market risk is more short term in nature, and that hedge funds provide higher benefits of diversification, the longer the horizon.

Modeling volatility and changes in the swap spread

We investigate the determinants of changes in U.S. interest rate swap spreads using a model that explicitly allows for volatility interactions between swaps of different terms to maturity. Changes in the swap spread are found to be positively related to interest rate volatility, to changes in the default risk premium in the corporate bond market, and to changes in the liquidity premium for government securities. Swap spread changes are negatively related to changes in the level of interest rates and changes in the slope of the term structure. We also find that there is a strong and significant volatility interaction among spreads for swaps of different maturities and that the process for the conditional variance of the spread is highly persistent across all maturities.

Modeling the Determinants of Swap Spreads

The authors use a multivariate exponential generalized autoregressive conditional heteroscedasticity (EGARCH) model to investigate the determinants of interest rate swap spreads in Australia. They find that changes in the spread are negatively related to changes in the level of default-free interest rates and to changes in the slope of the term structure. The curvature factor of the term structure is found to be a poor proxy in explaining changes in the spread. There is a strong and significant volatility interaction among spreads for swaps of different terms to maturity. The process for the conditional variance of the spread is highly persistent across all maturities. Credit risk but not swap market liquidity is also an important source of variation in Australian swap spreads.

Modelling Linkages Between Australian Financial Futures Markets

This paper investigates the dynamic interdependence of the Australian financial futures markets. We develop a multivariate EGARCH model to investigate linkages and stochastic volatility interactions between the 10-year Treasury bond, 90-day bank-accepted bill, and the All Ordinaries share price index futures markets. In this analysis, our empirical results strongly suggest that significant volatility interactions are evident across the three markets.

Portfolio allocation and the investment horizon: a multiscaling approach

A new approach is proposed for analysing portfolio allocation over various time scales. This new approach is based on wavelet analysis, which decomposes a given time series on a scale-by-scale basis. Empirical results indicate that, as the investment horizon lengthens, a greater weighting should be allocated to stocks. An explanation for this result is that the mean-reverting property of stock returns causes investors to perceive that stocks are less risky than bonds and T-bills at longer time scales compared with shorter time scales. When we include the effect of risk aversion, it is found that the higher the risk aversion, the less the Sharpe ratio, indicating that a more conservative investor prefers a smoother consumption stream.

What drives the term and risk structure of Japanese bonds

Abstract This paper investigates the long-run equilibrium implications of the Expectations Hypothesis of the term structure on different maturities of high-grade yen Eurobonds and Japanese Government Bonds (JGBs) using the Canonical Cointegrating Regression (CCR) technique developed by [Econometrica 60 (1992) 119]. Consistent with the Expectations Hypothesis, there is some evidence of long-run equilibrium relationship between JGBs and high-grade yen Eurobonds. Furthermore, the most liquid, long-term JGBs tend to drive the yen Eurobond term structure, with short-term yields adjusting to movements in the long-term yields.

Sovereign Credit Default Swaps, Sovereign Debt and Volatility Transmission Across Emerging Markets

This paper uses daily sovereign credit default swap (CDS) prices to investigate how the credit risks of major Latin American reference entities are interlinked. Our empirical findings suggest that the underlying creditworthiness of nations is reflected in the direction of Granger causality and volatility transmission, and in the degree of volatility persistence. These findings are robust when derived from Latin American government bond credit spreads, yet some important differences emerge which indicate that the sovereign CDS market provides a better forum for diversification of credit risk exposure than does the bond market.