Haim Reisman

Short-Term Predictability of the Term Structure

This research shows significant short-term momentum in U.S. Treasury yields. The evidence comes from principal components analysis of the term structure, and then modeling the two leading factors as ARIMA processes. Application of the prediction results to bond portfolio selection indicates frequent rebalancing of bond allocations may lead to substantially higher returns.

Preferences on relative return: A potential explanation for some pricing anomalies

We derive a version of the CAPM in which investor preferences depend only on the mean and variance of the ratio between the portfolio return and a reference return. The reference return is specific to each investor, and can also be interpreted as a proxy of the consumption of his neighbors. That is, investors in our economy care about how much they consume relative to their neighbors. The model provides a rational potential explanation for the home bias enigma and for other pricing anomalies.

Some comments on the APT

Abstract The paper reviews some aspects of arbitrage pricing theory (APT). It derives an improved version of the model and examines it in view of the APT debate, adding some new observations in favour of the model. The topics examined include: (a) model testability; (b) implications of approximate APT pricing to Fama-Macbeth testing methodology; and (c) a comparison between APT pricing and approximate exact pricing.

Accounting Data and Asset Valuation: Theory

Firms and divisions which are not traded on organized exchanges are often valued without the benefit of market data. Accounting data is used instead. One suggested approach is to use accounting beta as a proxy for market return beta. In the context of the Arbitrage Pricing Theory, we provide a theoretical justification for such a procedure. Our results provide a set of sufficient conditions so that return betas and accounting betas are equal. Our results also suggest a general methodology for evaluating projects and untraded firms using accounting data. The method underlying the derivation here is very general and can be applied in deriving testable restrictions between fundamentals, broader in context than that of accounting variables.

Price fluctuations when only prices reveal information

Abstract This paper provides a qualitative explanation for the observation that prices in financial markets fluctuate even in periods in which no agents receive any new information. This phenonmenon is explained in the framework of an equilibrium of prices, plans and price expectation in the style of Radner (1972) in the case of asymmetric information.

Black and Scholes pricing and markets with transaction costs: An example

Abstract. The paper shows that in the presence of transaction costs, there exists a viable price system in which prices of call options are arbitrarily close to the price of the stock. The construction of such an example is possible no matter how small the volatility of the stock or how small the transaction costs.

Pricing Currency Options in the Presence of a Target Zone

The paper characterizes the class of all one dimensional diffusion exchange rate processes that lie strictly inside a target zone. This characterization is done in the risk-neutral probability, which is practically all that is needed for the purpose of option pricing. The basic version of the model is extended to a model for pricing options on a single currency which is included in a target zone-constrained currency basket. Another extension is the calibration of the model so that it is consistent with any given domestic term structure of interest rates.

On Implied Binomial Trees With a Non Constant Interest Rate Dynamics

The paper examines a market for a stock, discount bonds of all maturities and European calls and puts on the stock of all strikes and all maturities. It derives a discrete time arbitrage free model. Said model is implemented in the binomial framework world in which both stock and bonds dynamics are determined so that risk neutral prices of the calls, exhibit the above smile and put prices are determined by the put-call parity. Fitting is done by deriving an algorithm which allows the interest rate process to be chosen specifically in order to generate fitting while keeping the stock’s volatility constant. As a result the initial market’s smile is allowed to be preserved forever, independently of time and state. The idea of using both stock and bonds in order to derive the local fit (and not viewing the bond dynamics as a given) is new. In this paper we extend the standards implied binomial models, to obtain a more flexible model which is calibrated with market data on European puts and calls. Constructing implied trees from a given smile along with a requirement for the model prices to be fair, generally involves solving a set of the well known CRR-equations under the restriction that the probability at each node is risk-neutral. The success of having a unique solution depends, among others, on the smile’s shape and can be easily violated by a quite steep one. Our model suggests a different approach by considering an optimization procedure. The model uses Brent method which incorporates other well known optimization methods. It is very stable for convergence and although complex it can easily be applied through Matlab program.

Fitting a Smile Exhibiting Sticky Moneyness: by Calibrating Both Bond and Stock Dynamics

The paper examines a market for a stock, discount bonds of all maturities, and European calls and puts on the stock of all strikes and all maturities. It derives an arbitrage free model in which the initial smile (quoted in terms of moneyness and time to maturity) is as we fix it to be, and will remain forever equal to its initial value. This is done by deriving a model in which both the stock and the bonds dynamics are determined such that risk neutral prices of the calls exhibit the above smile, and put prices are determined by the put-call parity. The idea of using both the stock and the bonds in order to do the fitting (and not viewing bond dynamics as given) is new.The paper examines a market for a stock, discount bonds of all maturities, and European calls of all strikes and all maturities on the stock. The implied volatility of a call in this market is a function, of our choice, of time to maturity and monyness that does not change over time. Our paper determines a dynamics for the prices of the stock and the bonds so that the implied volatility will be as above. The difference between our work and the literature on fitting the volatility smile, started by Derman and Kani (1994) and Dupire (1994), is that we are fitting the desirable smile at all future times, while they fit it only at the initial time. The source of our superior fitting ability is that we view the bonds and the stock (and not only the stock) as the underlying that we are allowed to determine its dynamics in order to obtain the fit, while they allow only to determine the dynamics of the stock.

Instantaneous Mean-Variance Analysis of Bond Returns

An explicit formula for the instantaneous expected return of any bond can be used to determine the mean-variance efficient frontier of instantaneous bond returns. Fitting the model to historical U.S. Treasury quotes, the analysis anticipates very high Sharpe ratios. The empirical findings support this prediction.