Pierre Hillion

Price Discovery and Learning during the Preopening Period in the Paris Bourse

Before the opening of the Paris Bourse, traders place orders and indicative prices are set. This offers a laboratory to study empirically the tâtonnement process through which markets discover equilibrium prices. Since preopening orders can be revised or canceled before the opening, indicative prices could be noise. We test this against the hypothesis that preopening prices reflect learning. Early in the preopening the noise hypothesis is not rejected. As the opening gets closer, the informational content and efficiency of prices increase and the learning hypothesis is not rejected. We also propose a GMM‐based estimate of the speed of learning.

The relevance of currency risk in the EMU

We investigate how the elimination of intra-European exchange risk may affect international financial markets using a conditional version of the International CAPM. We estimate the EMU and non-EMU components of aggregate currency risk and document significant exposures to both. The premium for EMU risk is positive and associated with exposure to the French, Italian and Spanish currencies. The premium for non-EMU risk is consistently negative and accounts for most of the aggregate currency premiums. In the 1990s, exposures to EMU risk declined significantly while exposures to non-EMU risk increased. Hence the adoption of the Euro is unlikely to have a large impact on aggregate currency risk premiums.

Diversification Benefits of Funds of Hedge Funds: Identifying the Optimal Number of Hedge Funds

This article introduces a new analytic framework to assess the risk/return profile of hedge funds and funds of hedge funds. As alternatives to the traditional time-series mean and standard deviation, the cross-sectional average and dispersion of the terminal wealth accumulated from an investment in baskets of hedge funds are used here. The end-of-period wealth approach circumvents well-known statistical biases marring parametric time-series analysis, especially the under-estimation of risk. Simulations performed in this article indicate that the risk of single hedge funds is much higher within a terminal wealth framework as compared to the traditional framework. However, this higher risk exposure can be channeled by investing in funds of hedge funds, the diversification benefits of which are found to be substantial. In addition, a small number of funds are necessary to diversify risk away. The terminal wealth framework should be particularly relevant for investors with fixed investment horizons and predefined liabilities to meet, such as pension funds and insurance companies

Local parametric analysis of derivatives pricing and hedging

A novel methodology for the analysis of derivatives pricing in incomplete markets is tested empirically. The methodology generates hedge ratios and derivatives prices. They are estimated from the correlation structure between the local co-movements of securities prices. First, the hedge ratios from a parsimonious complete-market model are estimated by fitting locally the changes in the derivatives and the underlying securities prices. Second, derivatives prices are obtained from the locally estimated hedge ratios. The methodology, referred to as local parametric estimation, is tested on a dataset of DAX index options and futures transactions from the computerized German Futures Exchange.

Country, Sector or Style: What Matters Most when Constructing Global Equity Portfolios? An Empirical Investigation from 1990-2001

Equity returns are believed to be strongly influenced by country, sector and style effects. A key issue is to be able to disentangle those various effects from one another. In particular, differences between country returns may simply reflect differences in the sector composition of country markets, which makes it clearly difficult to disassociate both effects. Similarly, from 1999-2001 the relative perfor-mance of Growth versus Value might be solely due to the striking performance of the Technology and Telecommunication sectors. For global equity portfolio man-agers, it is crucial to identify which factors offer the highest diversification benefits and return potential. We apply a multi-factor approach to estimate ”pure” coun-try, sector and style factor returns. Using data going back to 1990, we identify the major changes that have occurred in developed markets until 2001. Our various indicators clearly point out the growing influence of sector factors. However, coun-try effects remain important and there is no clear-cut evidence that sector factors dominate country factors. Style factors such as Growth, Value and Size also remain significant, even once sector and country effects are deduced. Finally, we show that momentum strategies based on sector returns offer substantial gains, while momen-tum strategies based on country returns do not. These findings suggest that, while diversification and return benefits from sector strategies have become substantial, managers should continue to monitor carefully country as well as style rewards and risks.

Testing The Mean-Variance Efficiency of Well-Diversified Portfolios in Very Large Cross-Sections

We propose a new way of testing the mean-variance efficiency of well-diversified portfolios on large cross-sections of extremely short return histories. The methodology consists of a sequence of simple tests, the results of which are aggregated in a statistic. This statistic is shown to be asymptotically standard normally distributed, despite dependence, in cross-section and over time, of the idiosyncratic risk. We investigate theoretically the asymptotic power of our test against the alternative that the well-diversified portfolio is not mean-variance efficient. By construction, our procedure is more powerful than standard tests of mean-variance efficiency that combine the assets in the cross-section into a limited set of (arguably) arbitrary portfolios. Even in cases where the latter has zero power, it can have unit asymptotic power. The incremental power is evidenced in tests of the mean-variance efficiency of the value weighted portfolio of common stock listed on the NYSE and AMEX. Unlike previously thought, however, the selection bias caused by including only continuously traded securities in the test is found to be important. By running the test in a case where it is known to have zero power, we are able to empirically confirm the correctness of the theoretical asymptotic properties of our statistic.