Mikael Petitjean

Trading Activity, Realized Volatility and Jumps

This paper takes a new look at the relation between volume and realized volatility. In contrast to prior studies, we decompose realized volatility into two major components: a continuously varying component and a discontinuous jump component. Our results confirm that the number of trades is the dominant factor shaping the volumevolatility relation, whatever the volatility component considered. However, we also show that the decomposition of realized volatility bears on the volume-volatility relation. Trade variables are positively related to the continuous component only. The well-documented positive volume-volatility relation does not hold for jumps.

Short-term market timing using the bond-equity yield ratio

The Bond-Equity Yield Ratio (BEYR) has recently become a popular relative pricing tool favored by market practitioners. In this paper we compare the short-term profitability of a naive strategy based on the extreme values of the BEYR to the short-term profitability of a more sophisticated strategy relying on regime switches. Although the latter seems to perform better than the former, there is no overwhelming international evidence that these dynamic strategies deliver significantly higher risk-adjusted returns than the buy-and-hold portfolios. In addition, the profitability of these active strategies does not appear to be significantly different when the equity yield, instead of the BEYR, is used as criterion to time the market.

On the statistical and economic performance of stock return predictive regression models: an international perspective

The predictability of stock returns is assessed in 10 countries using the linear predictive regression framework. We use recently developed out-of-sample statistical tests and include both valuation ratios and interest rates as predictive variables. Contrary to previous studies, we explicitly address the issue of the small-sample bias, deal with trading profitability, and employ several risk-adjusted metrics. When statistical forecastability is found, it cannot be exploited to consistently deliver abnormal returns across countries and investment horizons. We hold the view that returns are predictable to some extent, but show that such forecasts are not useful for portfolio advice.

Bank Failures and Regulation: A Critical Review

Purpose - The purpose of this paper is to define the key components of an effective regulatory regime. Design/methodology/approach - The paper takes the form of a critical analysis. Findings - Regulatory arbitrage has been one of the major factors contributing to the severity of the crisis. Given the ever more complex set of future regulatory constraints, it may keep generating costly negative spillover effects on the whole economy. Moreover, rules-based regulation, however carefully constructed, will unfortunately never prevent bank failures. Neither should it attempt to do so. An effective overall regulatory regime must be sufficiently comprehensive and well-balanced. It must not put too much emphasis on lowering the probability of individual bank failure. The key components of an effective regulatory regime must be: Basel-type rules robust to off-balance-sheet arbitrage; little forbearance in monitoring and supervision by regulatory agencies, with a focus on systemic risk control; automatic and quick intervention as well as resolution mechanisms. While all components are necessary, none is sufficient; and without strong international coordination, none will be effective. Practical implications - Enhanced supervision of banks. Social implications - Less costly bank failures. Originality/value - The paper presents a critical review of current financial reforms in the banking sector.

International stock return predictability: statistical evidence and economic significance

The predictability of stock returns in ten countries is assessed taking into account recently developed out-of-sample statistical tests and risk-adjusted metrics. Predictive variables include both valuation ratios and interest rate variables. Out-of-sample predictive power is found to be greatest for the short-term and long-term interest rate variables. Given the importance of trading profitability in assessing market efficiency, we show that such statistical predictive power is economically meaningless across countries and investment horizons. All in all, no common pattern of stock return predictability emerges across countries, be it on statistical or economic grounds.

The performance of popular stochastic volatility option pricing models during the Subprime crisis

Using daily options prices on the Eurostoxx 50 stock index over the whole year 2008, we compare the performance of three popular Stochastic Volatility (SV) models (Heston, 1993; Bates, 1996; Heston and Nandi, 2000), in addition to the traditional Black–Scholes model and a proprietary trading desk model. We show that the most consistent in-sample and out-of-sample statistical performance is obtained for the internal model. However, the Bates model seems to be better suited to Short Term (ST, out-of-the-money) options while the Heston model seems to perform better for medium or Long Term (LT) options. In terms of hedging performance, the Heston and Nandi model exhibits the best average, albeit most volatile, result and the Heston model outperforms the Black–Scholes model in terms of hedging errors, mainly for option contracts that mature in-the-money.

To what extent is resampling useful in portfolio management

We take a new look at the resampled efficiencyTM technique developed by Michaud (1998) and compare it with the Markowitz mean–variance portfolio construction technique by assessing the performance of three representative portfolios, i.e. the Global Minimum Variance (GMV) portfolio, the Intermediate Return (I) portfolio and the Maximum Return (M) portfolio. We show that resampling leads to more stable and more diversified portfolios. However, the out-of-sample analysis shows that resampling does not systematically increase (decrease) the risk adjusted performance (turnover) of the portfolios.

Implicit transaction cost management using intraday price dynamics

ABSTRACT Using the Exchange Liquidity Measure, we show that implicit transaction costs exhibit intraday regularities around specific price change signals for a sample of European blue chips publicly quoted on Euronext. Not only transaction costs follow a reverse J-shape throughout the day but they also decrease significantly around specific patterns of price dynamics. By focusing on these signals during the trading day, liquidity traders may detect intraday windows of opportunities during which implicit transaction costs are lower.

Testing the effect of technical analysis on market quality and order book dynamics

ABSTRACT We find empirical support for the theoretical finding in agent-based models of limit order book markets that the effect of technical trading on market quality is not positive. When signals occur, technical traders lower liquidity as proxied by the relative spread, the effective spread, the realized spread, the dispersion and the slope in the order book. Technical trading is also found to be accompanied by rising volatility. There is overall strong empirical support against the hypothesis that technical trading has no effect on order book dynamics.

Extreme events and the cumulative distribution of net gains in gambling and structured products

ABSTRACT We argue that ethical principles in advertising and market communication cannot be properly discovered and applied to gambling without a deep understanding of its probabilistic implications, in particular when extreme events are influential. We carry out a probabilistic analysis of lottery games with lifetime prizes in order to derive sound recommendations about the pertinent information that should be communicated to nudge gamblers. We propose to focus on the cumulative distribution of net gains, for which there is currently no information available to gamblers. This holds true for structured products in which extreme events matter as well.