Frans de Roon

Hedging Pressure Effects in Futures Markets

We present a simple model implying that futures risk premia depend on both own-market and cross-market hedging pressures. Empirical evidence from 20 futures markets, divided into four groups (financial, agricultural, mineral, and currency) indicates that, after controlling for systematic risk, both the futures own hedging pressure and cross-hedging pressures from within the group significantly affect futures returns. These effects remain significant after controlling for a measure of price pressure. Finally, we show that hedging pressure also contains explanatory power for returns on the underlying asset, as predicted by the model. Copyright The American Finance Association 2000.

Testing for Mean‐Variance Spanning with Short Sales Constraints and Transaction Costs: The Case of Emerging Markets

We propose regression-based tests for mean-variance spanning in the case where investors face market frictions such as short sales constraints and transaction costs. We test whether U.S. investors can extend their efficient set by investing in emerging markets when accounting for such frictions. For the period after the major liberalizations in the emerging markets, we find strong evidence for diversification benefits when market frictions are excluded, but this evidence disappears when investors face short sales constraints or small transaction costs. Although simulations suggest that there is a possible small-sample bias, this bias appears to be too small to affect our conclusions. Copyright The American Finance Association 2001.

An Anatomy of Commodity Futures Risk Premia

We identify two types of risk premia in commodity futures returns: spot premia related to the risk in the underlying commodity, and term premia related to changes in the basis. Sorting on forecasting variables such as the futures basis, return momentum, volatility, inflation, hedging pressure, and liquidity, results in sizable spot premia in the high-minus-low sorted portfolios between 5% and 14% per annum and term premia between 1% and 3% per annum. We show that a single factor, the high-minus-low portfolio from basis sorts, explains the cross-section of spot premia. Two additional basis factors are needed to explain the term premia.

Evaluating Style Analysis

In this paper we evaluate applications of (return based) style analysis. The portfolio and positivity constraints imposed by style analysis are useful in constructing mimicking portfolios without short positions. Such mimicking portfolios can be used e.g. to construct efficient portfolios of mutual funds with desired factor loadings if the factor loadings in the underlying factor model are positively weighted portfolios. Under these conditions style analysis may also be used to determine a benchmark portfolio for performance measurement. Attribution of the returns on portfolios of which the actual composition is unobserved to specific asset classes on the basis of return based style analysis is attractive if moreover there are no additional cross exposures between the asset classes and if fund managers hold securities that on average have a beta of one relative to their own asset class. If such restrictions are not met, and in particular if the factor loadings do not generate a positively weighted portfolio, the restrictions inherent in return based style analysis distort the outcomes of standard regression approaches rather than that the analysis is improved. The size of the distortions is illustrated by considering empirical results on style analysis of US mutual funds.

Announcement effects of convertible bond loans versus warrant-bond loans : An empirical analysis for the Dutch market

This study investigates the announcement effects of offerings of convertible bond loans and warrant-bond loans using data for the Dutch market. Using standard event study methodology it is found that on average stock prices show a positive but insignificant abnormal return for the announcement of a convertible bond loan and a significant positive abnormal return for the announcement of a warrant-bond loan. These findings contrast with studies for the United States which generally find significant negative abnormal returns for convertible bond loans and negative but no significant abnormal returns for warrant-bond loans. This can be explained by the fact that Dutch companies generally package these announcements with other (good) firm specific news. Using regression analysis, in which the amount of new equity and new debt involved in the issue are taken into account, it is found that shareholders react more positively to the announcement of warrant-bond loans than to the announcement of convertible bond loans.

The Price of Commodity Risk in Stock and Futures Markets

Commodity prices are a risk factor that directly in‡uences in‡ation for consumers as well as input and output prices for …rms. We sort stocks according to their beta with respect to a broad index of commodity futures and …nd that commodity risk is priced. Our cross-sectional regressions imply that a unit exposure to commodity risk is rewarded with a premium of around 5% pre-2004 and -8.5% post-2003. We argue that commodity risk is likely to proxy for in‡ation risk and attribute the reversal to the surge in commodity index investment by institutions in the early 2000s. In a simple model in which investors are exposed to exogenous in‡ation risk, a switch from hedging in the stock market to hedging directly in the commodity market easily leads to the observed reversal in the risk premium. Both time-series and cross-sectional tests imply that the commodity factor is a separate additional risk factor, not replacing the traditional Fama-French-Carhart factors. JEL Classi…cation Codes: G11, G12, G13

Put-call parities and the value of early exercise for put options on a performance index

In this paper we use the put-call parity to calculate the premium for early exercise of put options on the DAX index. Because this is a performance index, it is not necessary to separate this premium from the early exercise premium of a call option. We find the early exercise premium of a put option to be positively correlated with the moneyness and the standard deviation of the returns on the index.

Asset Pricing Restrictions on Predictability: Frictions Matter

U.S. stock portfolios sorted on size; momentum; transaction costs; market-to-book, investment-to-assets, and return-on-assets (ROA) ratios; and industry classification show considerable levels and variation of return predictability, inconsistent with asset pricing models. This means that a predictable risk premium is not equal to compensation for systematic risk as implied by asset pricing theory. We show that introducing market frictions relaxes these asset pricing moments from a strict equality to a range. Empirically, it is not short sales constraints but transaction costs (below 35 basis points) that help to reconcile the observed predictability with linear portfolio return-based factor models, and partly with the durable consumption model. Across the sorts, predictability in industry returns can be reconciled with all models considered with only a 25 basis point transaction cost, whereas for momentum and ROA portfolios, up to 115 basis points are needed. This paper was accepted by Wei Xiong, finance.

A Simple Skewed Distribution with Asset Pricing Applications

Recent research has identified skewness and downside risk as one of the most important features of risk. We present a new distribution which makes modeling skewed risks no more difficult than normally distributed (symmetric) risks. Our distribution is a combination of the “downside” and “upside” half of two normal distributions, and its parameters can be calculated in closed form to match a given mean, variance, and skewness. Value at risk, expected shortfall, portfolio weights, and risk premia have simple expressions for our distribution and show economically meaningful deviations from the normal case already for very modest levels of skewness. An empirical application suggests that our distribution fits the data well.

The Stock Market Price of Inflation Risk and Its Variation over Time

The inflation risk premium (IRP) in the U.S. stock market varies over time. We use individual stocks to estimate the IRP, because this provides us with a heterogeneous cross-section of exposures. We find that the IRP is a significant -5.5% since the 1960s, but reverses to an insignificant positive value in the recent decade. Consistent with this reversal, we find that the IRP is more negative in recessions historically, but more positive in the two latest recessions. We show that both the introduction of Treasury Inflation Protected Securities (TIPS) in 1997, an attractive alternative inflation hedge, and a reversal in the covariance between inflation and the real economy at the end of the 1990s contribute to this reversal. These findings are consistent with inflation as a state variable in the intertemporal capital asset pricing model (ICAPM).