John Board

The Effect of Futures Market Volume on Spot Market Volatility

There has been considerable interest, both academic and regulatory, in the hypothesis that the higher is the volume in the futures market, the greater is the destabilizing effect on the stock market. We show that conventional approaches, such as adding exogenous variables to GARCH models, may lead to false inferences in tests of this question. Using a stochastic volatility model, we show that, contrary to regulatory concern and the results of other papers, contemporaneous informationless futures market trading has no significant effect on spot market volatility.

Applying operations research techniques to financial markets

OR techniques are applied to nonportfolio problems in financial markets, such as the equity, debt, and foreign exchange markets and the corresponding derivatives markets. Finance problems are an excellent application area for OR researchers. OR techniques are used to value financial instruments, identify market imperfections, design securities, regulate markets, evaluate and control risks, model strategic problems, and understand the functioning of financial markets. Mathematical programming is probably the most widely applied OR technique, but Monte Carlo simulation methods are of increasing importance. With the improvements in the real-time availability of data and the power of computers, the role of OR techniques in financial markets can only increase.

The performance of covered calls

Writing call options against long positions in the underlying equities is the most popular options strategy. Since the variance is an inadequate measure of risk for options strategies, this paper uses a range of dominance criteria and four utility functions to compare the performance of partly and fully covered call strategies with that of the underlying equity portfolio. It is found that the dominance criteria are ineffective in choosing between strategies. However, all four utility functions (representing different combinations of absolute and relative risk aversion) find that the covered call strategy is preferable for the data period studied, supporting the widespread use of this strategy.

The Dual Listing of Stock Index Futures: Arbitrage, Spread Arbitrage and Currency Risk

This paper shows that riskless spot-futures arbitrage is impossible if the futures contract multiplier is in a foreign currency from that of the underlying shares. However, a no-arbitrage condition involving only futures contracts (spread arbitrage) exists for such cases when there is also a future with a contract multiplier in the same currency as the underlying shares. Where the contract multiplier of the second future is in a foreign currency, virtually riskless arbitrage is possible. Mispricings from this no-arbitrage condition were investigated for Nikkei Stock Average futures traded in Osaka, Singapore, and Chicago.

Designing Secondary School Catchment Areas Using Goal Programming

Falling school rolls have necessitated the widespread revision öf school catchment areas. It is argued that an appropriate technique for solving this problem is weighted goal programming. A study of Reading has shown that this technique is feasible and can produce results that dominate those produced by the ad hoc methods of the local education authority. Since goal programming is a very flexible technique, various ways of developing this approach to designing catchment areas are considered. Among these developments are the inclusion of additional goals (such as safety, parental choice, and compactness), goal interaction, allowance for the effects of parental choice, multiperiod models incorporating school closures, and the allocation of entire primary schools. The effects of the redefinition of the decision variable to require the joint allocation of the boys and girls at the same primary school are investigated using data for Reading.

The Proof of the Pudding: The Effects of Increased Trade Transparency in the London Stock Exchange

The trade publication rules of the London Stock Exchange were changed on 1 January, 1996, to increase transparency. This paper investigates whether these changes affected market behaviour by examining data on 60 firms from the FTSE 100, FTSE Mid 250 and the FTSE Small Cap indices before and after this rule change. This study finds there has been a major increase in transparency, with no detrimental effects on the quality of the market. In particular, neither the volume nor the traded bid-ask spread has been adversely affected. Copyright Blackwell Publishers Ltd 2000.

Market Maker Performance: The Search for Fair Weather Market Makers

The London Stock Exchange has long been concerned that some market makers do not fulfill their obligations. This study describes a range of measures to identify such fair weather market makers. The results indicate that three firms of market makers meet the criteria for fair weather market making. It is also discovered that market makers in a given stock all quote the same fixed spread in round pennies and that this is about twice the touch. Internalized order flow is pervasive, with market makers receiving 57% of their order flow from associated brokers. However, fair weather market making is found to be distinct from order preferencing and internalization.

Chapter 21 – Joined-up pensions policy in the UK: An asset-liability model for simultaneously determining the Asset allocation and contribution rate

Publisher Summary This chapter develops an approach to the simultaneous analysis of two critical and interrelated decisions which must be made by any funds trustees: the funds asset allocation and its contribution rate. This model is applicable to a wide range of pension schemes, and illustrates with reference to a particular very large pension scheme–the Universities Superannuation Scheme. The trustees of funded benefit pension schemes must make two vital and interrelated decisions—setting the asset allocation and the contribution rate. While these decisions are usually taken separately, it is argued that they are intimately related and should be taken jointly. The objective of funded pension schemes is taken to be the minimization of both the mean and the variance of the contribution rate, where the asset allocation decision is designed to achieve this objective. This is done by splitting the problem into two main steps. First, the Markowitz mean-variance model is generalized to include three types of pension scheme liabilities, and this model is used to generate the efficient set of asset allocations. Second, for each point on the risk-return efficient set of the asset-liability portfolio model, the mathematical model of Haberman is used to compute the corresponding mean and variance of the contribution rate and funding ratio. Since the Haberman model assumes that the discount rate for computing the present value of liabilities equals the investment return, it is generalized to avoid this restriction. This generalization removes the trade-off between contribution rate risk and funding ratio risk for a fixed spread period. Pension schemes need to choose a spread period, and it is shown how this can be set to minimize the variance of the contribution rate. Finally, using the result that the funding ratio follows an inverted gamma distribution, shortfall risk and expected tail loss are computed for funding below the minimum funding requirement, and funding above the taxation limit. This model is then applied to one of the largest UK pension schemes—the Universities Superannuation Scheme.

A New Regulatory Framework

In this chapter we put forward a regulatory structure that we believe may be more suited to the environment as it is likely to develop.

The application of operations research techniques to financial markets

This paper reviews the application of OR to financial markets. After considering reasons for the attractiveness of general finance problems to Or researchers, the main types of financial market problem amenable to OR are identified, and some of the many problems solved using OR are documented.