Mondher Bellalah

Valuation of futures and commodity options with information costs

In this article, futures and commodity options are analyzed in the context of Mertons (1987) model of capital market equilibrium with incomplete information. First, following Dusak (1973) and Black (1976), the conditions under which Mertons model can be applied to the valuation of forward and futures contracts are proposed. Then an application to futures markets is given. We provide a partial differential equation and the formulas for European commodity options, futures contracts, and American options in the same context. The models are simulated and compared to standard models with no information costs. We find that model prices are not significantly different from standard model prices. However, our models correct for some pricing biases in standard models. In particular, they reduce the overvaluation bias for European and American commodity options. It seems that the costs of gathering and processing information regarding the option and its underlying asset play a role in explaining the biases observed in standard models. This work can be applied to other futures markets.

Irreversibility, sunk costs and investment under incomplete information

Publisher Summary This chapter describes some simple models for the analysis of the investment decision under uncertainty, irreversibility, and sunk costs like shadow costs of incomplete information. In Mertons model, the expected returns increase with systematic risk, firm-specific risk, and relative market value. The expected returns decrease with relative size of the firms investor base, referred to in Mertons model as the degree of investor recognition. The chapter also illustrates how optimal investment rules can be obtained using real option theory under shadow costs of incomplete information. The chapter also presents a justification for the foundations of information costs in investment decisions. These costs are based on the shadow costs of incomplete information in the spirit of Mertons model. In addition, the chapter also provides a basic continuous-time model of irreversible investment in the presence of information costs. This model shows when the firm should invest in a project in the presence of incomplete information. Following this, the basic model is extended so that the price of the firms output is random and the firm can stop production whenever the price falls below variable cost. The value of the project and the value of the firms option are derived to invest in the project as well as the optimal investment rule in the presence of information costs. Simulations are provided to illustrate the main results. Finally, the chapter compares some of the results with respect to some standard models.

THE COMOVEMENTS IN INTERNATIONAL STOCK MARKETS: NEW EVIDENCE FROM LATIN AMERICAN EMERGING COUNTRIES

We analyse the time variations in the comovements of Latin American stock markets. Conditional correlations are estimated from the dynamic conditional correlation GARCH model. Then, Bai and Perrons (2003) structural break technique is employed to test for changing nature of market comovements. Main findings are as follows. First, the degree of cross-market comovements changed over time and has significantly increased since 1994. However, room for international diversification still remains largely possible. Second, the comovements are subjected to various regime shifts, essentially due to major economic events. Finally, stock markets move much more together in times of crisis.

Evaluation of Real Options with Information Costs

This paper presents a simple framework for the analysis, valuation and simulation of several real options in the presence of shadow costs of incomplete information. Information costs can be viewed as sunk costs in the spirit of Merton’s (1987) model of capital market equilibrium with incomplete information. We incorporate these sunk costs in standard discounted cash flow techniques and present the basic concepts of real options. The justification of information costs in real projects is based on the observation that R&D needs to be done before investment decisions. These costs account for all the expenses needed to be informed about an investment opportunity and the management of projects. This analysis extends the models in Bellalah (1999, 2001) for the valuation of real options within information uncertainty. We present valuation procedures and simulations for the values of common real options in the presence of shadow costs of incomplete information.

A MODEL FOR MARKET CLOSURE AND INTERNATIONAL PORTFOLIO MANAGEMENT WITHIN INCOMPLETE INFORMATION

This paper presents of model of market closure in the management of international portfolios. We consider an investor holding a portfolio of domestic stocks and foreign stocks who faces market closure in the management of his portfolio. The investors portfolio is affected by the exchange rate risk and different dynamics of the underlying assets during the period of trading and non-trading. The investor must determine the optimal proportions of his wealth to allocate to domestic stocks and foreign stocks during the market open and close periods. The paper investigates the effects of opening and closing on transactions demand of domestic and foreign stocks. The transactions demand at open and close periods in the securities markets are studied in the presence of information costs using the main concepts in Mertons (1987) model of capital market equilibrium with incomplete information. Using optimal control theory, we provide a solution in the general case and propose analytic solutions for the constant relative aversion utility functions. The model can be applied to solve several problems in financial economics in the presence of market closure.

Nonlinear mean reversion in oil and stock markets

Purpose - While price studies such as Jawadi Design/methodology/approach - Using nonlinear econometric modeling, this paper investigates the oil market adjustment dynamics for four developed and emerging countries: France, the USA, Mexico and the Philippines. Our findings show strong evidence of significant linkages between oil and stock markets for all the countries under consideration. Findings - As in Jawadi Research limitations/implications - This paper develops a new nonlinear framework that should improve the investigation of oil-stock market linkages. Future research could check the forecasting properties of this model to forecast the future dynamics of oil prices. Originality/value - This paper adds to the literature by suggesting that it is not only oil shocks that affect stock markets, but that the latter also have a strong nonlinear impact on oil markets, reducing the diversification benefits of oil-stock portfolios.

On information costs, short sales and the pricing of extendible options, steps and Parisian options

This paper provides a simple framework for the valuation of exotic derivatives within shadow costs of incomplete information and short sales. The specific features of the OTC markets with comparison to the organized markets require an additional investment to obtain information about the financial products, to process data, to elaborate models, etc. The shadow cost includes two components. The first component is the product of pure information cost due to imperfect knowledge. The second component represents the additional cost caused by the short-selling constraint. Information costs are linked to Merton’s (J Fianance 42:483–510, 1987) model of capital market equilibrium with incomplete information, CAPMI. This model is extended by Wu et al. (Rev Quant Finance Account 7:119–136, 1996) who propose incomplete-information capital market equilibrium with heterogeneous expectations and short sale restrictions, GCAPM. This model is used in our paper to provide for the first time in the literature analytic solutions for derivatives in the presence of both shadow costs of incomplete information and short sales. Our methodology incorporates shadow costs of incomplete information and short sales in the options and their underlying securities. We provide formulas using the standard Black and Scholes method or the martingale method. Since shadow costs are important in the presence of illiquidity, the formulas are useful for the valuation of OTC derivatives.

Pricing derivatives in the presence of shadow costs of incomplete information and short sales

Financial models are based on the standard assumptions of frictionless markets, complete information, no transaction costs and no taxes and borrowing and short selling without restrictions. Merton’s (J Finance 42:483–510, 1987) develops a simple model of capital market equilibrium with incomplete information. Wu et al. (Rev Quant Finance Account 7:119–136, 1996) extend Merton’s (J Finance 42:483–510, 1987) model by proposing an incomplete information capital market equilibrium with heterogeneous expectations and short sale restrictions, GCAPM. The shadow costs include two components. The first component is the product of pure information cost due to imperfect knowledge and heterogeneous expectations. The second component represents the additional cost caused by the short-selling constraint. Short-selling bans around the world after the global financial crisis become more and more important. Nezafat and Wang (Short-sale constraints, information acquisition, and asset prices, Scheller College of Business, Georgia Institute of Technology, Atlanta, p 30308, 2013) develop a model of information acquisition and portfolio choice under short-sale constraints. Bellalah (J Futures Mark, 1999) and Bellalah and Wu (Ann Oper Res 165:123–143, 2009) include information costs the valuation of assets and derivatives. This is the first study to our knowledge devoted to the pricing of derivatives that accounts simultaneously for information costs and short sales constraints for the option market and its underlying asset market. We extend the classic models by Black and Scholes (J Polit Econ 81:637–659, 1973), Black (J Financ Econ 79(3):167–179, 1976), and Barone-Adesi and Whaley (J Finance 2(81):303–320, 1987) among others to account for shadow costs of incomplete information and short sales. We present a general method and provide the general differential equation for the pricing of derivatives within incomplete information and short selling costs.

Syariah accounting and compliant screening practices

Purpose - The purpose of this paper is to focus on the Design/methodology/approach - This research uses comparative analysis to recognize the similarities and differences of methods among 15 users. Findings - Analysis reveals that there is a need to set the universal standards, not only for the investors but also to discourage the misunderstanding between investors and scholars. After analysis of qualitative and quantitative screening, recommendations for both methods have been made for the Originality/value - The paper is useful for Islamic finance users, as well from the academic point of view and is new and unique in its nature.

Valuation of American CAC 40 index and wildcard options

Abstract American options traded on the CAC 40 index are cash settled. However, the stocks underlying the CAC 40 index are traded in a particular “forward” market. In this market, settlements take place periodically on a given date as in the UK. At that date, all transactions accomplished before are settled. The settlement procedure differs from that in countries where settlements appear as fixed number of business days after the transaction as in the US. The characteristics of the distributions to the index underlying stocks might justify a specific model for the valuation of these options. Besides, the organization of the Paris Bourse gives market participants the possibility to exercise their positions during the 45 min following the close of the stock exchange. They face each day as an exercise risk that must be accounted for. This article applies to existing models for the valuation of CAC 40 options, and this type of risk is identified as a wildcard option. This option is implicit in the values of index calls and puts. The magnitude of wildcard options in a multiperiod setting is studied empirically using a new dataset by adapting the model in Fleming and Whaley [J. Finance XLIX (1994) 215.] to the French market.