George Dotsis

Investor sentiment and value and growth stock index options

The paper examines the relationship between both individual and institutional investor sentiment measures and the risk-neutral skewness (RNS) of seven stock index options comprising either growth or value stocks. It provides novel evidence that growth index option prices are affected by sentiment measures. The regression results indicate a significantly positive relationship between sentiment measures and the RNS estimated from four growth index options and a negative relationship with two value index options. The results are economically significant since an associated long–short trading strategy yields high abnormal returns with a Sharpe ratio of up to 1.1 and zero exposure to systematic risk. These high abnormal returns provide evidence of a value premium type anomaly in the index options markets.

Nonlinear modelling of European football scores using support vector machines

This article explores the linear and nonlinear forecastability of European football match scores using IX2 and Asian Handicap odds data from the English Premier league. To this end, we compare the performance of a Poisson count regression to that of a nonparametric Support Vector Machine (SVM) model. Our descriptive analysis of the odds and match outcomes indicates that these variables are strongly interrelated in a nonlinear fashion. An interesting finding is that the size of the Asian Handicap appears to be a significant predictor of both home and away team scores. The modelling results show that while the SVM is only marginally superior on the basis of statistical criteria, it manages to produce out-of-sample forecasts with much higher economic significance.

Maximum Likelihood Estimation and Dynamic Asset Allocation with Non-Affine Volatility Processes

In this paper we develop an estimation method for extracting non-affine latent stochastic volatility and risk premia from measures of model-free realized and risk-neutral integrated volatility. We estimate non-affine models with nonlinear drift and constant elasticity of variance and we compare them to the popular square-root stochastic volatility model. Our empirical findings are: (1) the square-root model is misspecified; (2) the inclusion of constant elasticity of variance and nonlinear drift captures stylized facts of volatility dynamics; (3) models with linear drift imply an explosive volatility process under the risk-neutral probability measure. To gauge the economic impact of the empirical findings we also study the implications of non-affine specifications on dynamic asset allocation strategies with stochastic volatility. We show that, in contrast to the affine case, non-affine volatility models induce market timing and can generate volatility dynamics which are volatile enough to produce large intertemporal hedging demands.

Corridor Volatility Risk and Expected Returns

This paper examines the pricing of volatility risk using SPX corridor implied volatility. We decompose model‐free implied volatility into various components using different segments of the cross‐section of out‐of‐the money put and call option prices. We find that only model‐free volatility computed from the cross‐section of out‐of‐the‐money call option prices carries a significant negative risk premium in the cross‐section of stock returns and subsumes all relevant information for forecasting future volatility. Our empirical results provide strong evidence that SPX out‐of‐the money put option prices do not contain useful information for pricing aggregate volatility risk in the cross‐section of stock returns.

Extreme Volatility in Agricultural Commodity Markets and Implications for Food Security

Unexpected price changes and large upward/downward price swings have become very frequent and very common in the volatile agricultural markets. Sudden jumps in agricultural prices denote undesirable events for both policy makers and commodity producers, and create difficult situations for countries facing food security challenges. This is because unpredictable price increases raise the cost of food imports. The infrequent nature of these price changes makes it difficult to identify, anticipate and hedge them in a proper and timely fashion. Nevertheless, the nature of such events is important for food security planning. This is because low-income food deficit countries, which number 54 according to the latest 2015 list of the Food and Agriculture Organization (FAO) of the United Nations, may find it difficult to import at reasonable cost what they need in periods of international food commodity price spikes. The purpose of this chapter is to explore the nature of large basic food commodity price changes using extreme value theory tools.

Option-implied expectations in commodity markets and monetary policy

In this paper we estimate the dynamic interactions between option-implied variance and skewness in agricultural commodity markets and monetary policy. Using a structural vector autoregressive (SVAR) framework, we find that an expansionary (contractionary) monetary policy upwardly (downwardly) revises commodity markets’ expectations about the price and volatility path of agricultural products. On the other hand, our empirical analysis reveals that monetary policy does not have a systematic and timely response to sudden changes in option implied expectations of commodity investors. In addition, we provide empirical evidence showing the robust forecasting power of agricultural option-implied information on monetary policy with R2 values reaching almost 52%.

Environmental Policy Implications of Extreme Variations in Pollutant Stock Levels and Socioeconomic Costs

Motivated by recent evidence on the possibility of jumps in carbon dioxide emission levels and abrupt increases in pollutant-related socio-economic costs, this paper uses a real options approach to examine their impact with respect to the optimal timing of environmental policies and the optimal emissions abatement level. To this end, we extend the methodology of Pindyck (2000) using jump diffusion processes. We show that if pollutant stock levels are subject to extreme variations and the emissions abatement level is chosen exogenously by the policymaker, then environmental policy measures should be taken earlier. A similar, yet more prominent, effect is observed under the assumption that pollutant-related socio-economic costs and benefits are expected to exhibit abrupt changes. However, different results are obtained when we examine simultaneously the two interrelated decisions, namely, the optimal timing of emissions abatement and the optimal abatement level. In this case, an increase in the size and/or probability of a jump, delays policy adoption but leads to higher optimal abatement.

Investment under uncertainty and volatility estimation risk

This article considers the implications of volatility estimation risk in real options theory. We construct confidence intervals for critical project values and options prices. An empirical example in lease investment evaluation for an offshore petroleum tract shows that confidence intervals can be substantial when a limited amount of data are used to estimate volatility.

Option Pricing Methods in the Late 19th Century

City of London traders in the late nineteenth century had a much more advanced understanding of option pricing than previously thought

Investment Under Uncertainty When Interest Rates Are at the Zero Lower Bound

This paper examines irreversible investment decisions when interest rates are at the lower bound. A simple model is presented in which the shadow-rate model of Black (1995) is used for modeling interest rate uncertainty. It is shown that when interest rates are at the lower bound and the shadow rate is substantially below the bound the investment decision no longer depends on interest rate uncertainty. The decision to invest or wait is determined entirely by cash flow volatility. Monetary policy becomes ineffective because it cannot offset uncertainly shocks that increase the value of waiting. In contrast to extant approaches, the shadow rate model is consistent with prolonged periods of interest rates at the lower bound and low investment.