Ronald Mahieu

An empirical application of stochastic volatility models

This paper studies the empirical performance of stochastic volatility models for twenty years of weekly exchange rate data for four major currencies. We concentrate on the effects of the distribution of the exchange rate innovations for both parameter estimates and for estimates of the latent volatility series. The density of the log of squared exchange rate innovations is modelled as a flexible mixture of normals. We use three different estimation techniques: quasi-maximum likelihood, simulated EM, and a Bayesian procedure. The estimated models are applied for pricing currency options. The major findings of the paper are that: (1) explicitly incorporating fat-tailed innovations increases the estimates of the persistence of volatility dynamics; (2) the estimation error of the volatility time series is very large; (3) this in turn causes standard errors on calculated option prices to be so large that these prices are rarely significantly different from a model with constant volatility.

Neglected common factors in exchange rate volatility

The paper proposes a new multivariate model for exchange rate volatility in a system of bilateral exchange rates, using a factor structure of exchange rates one of the common factors is always related to the numeraire currency. Time variation in the volatility is modelled using a stochastic variance approach. The interpretation of the factors provides a new way of estimating risk premia in the foreign exchange market. Empirical results show considerable volatility spillovers among the four major currencies. Risk premia show a major sign reversal for the dollar risk premium around 1978.

Price discovery in the foreign exchange market: an empirical analysis of the yen/dmark rate

Abstract Using Reuters exchange rate data we investigate the dynamic relations between the direct quotes of the yen/dmark rate and the rate implied by yen/dollar and dmark/dollar rates. Since these high frequency data are observed at irregular intervals, technical problems arise in calculating auto-correlations and cross-correlations. We propose a covariance estimator for irregularly spaced data. The empirical results show lagged adjustment of the direct yen/dmark cross-rate to changes in the dollar implied rate. However, since the dollar implied rate is extremely noisy, substantial price discovery takes place through the direct yen/dmark market, especially during the most busy parts of the day.

Hourly Electricity Prices in Day-ahead Markets

This paper focuses on the characteristics of hourly electricity prices in day-ahead markets. In these markets, quotes for day-ahead delivery of electricity are submitted simultaneously for all hours in the next day. The same information set is used for quoting all hours of the day. The dynamics of hourly electricity prices does not behave as a time series process. Instead, these prices should be treated as a panel in which the prices of 24 cross-sectional hours vary from day to day. This paper introduces a panel model for hourly electricity prices in day-ahead markets and examines their characteristics. The results show that hourly electricity prices exhibit hourly specific mean-reversion and that they oscillate around an hourly specific mean price level. Furthermore, a block structured cross-sectional correlation pattern between the hours is apparent.

A Bayesian analysis of stock return volatility and trading volume

The relationship between stock return volatility and trading volume is analysed by using the modified mixture model (MMM) framework proposed by Andersen (1996). This theory postulates that price changes and volumes are driven by a common latent information process, which is commonly interpreted as the volatility. Using GMM estimation Andersen finds that the persistence in this latent process falls when a bivariate model of returns and volume, i.e. the MMM, is estimated instead of a univariate model for returns. This empirical finding is inconsistent with the MMM. As opposed to Andersens study we apply recently developed simulation techniques based on Markov Chain Monte Carlo (MCMC). A clear advantage of MCMC methods is that estimates of volatility are readily available for use in, for example, dynamic portfolio allocation and option pricing applications. Using Andersens data for IBM we find that the persistence of volatility remains high in the bivariate case. This suggests that the choice of the estimation technique could be important in testing the validity of the MMM.

A Range-Based Multivariate Stochastic Volatility Model for Exchange Rates

In this paper we present a parsimonious multivariate model for exchange rate volatilities based on logarithmic high–low ranges of daily exchange rates. The multivariate stochastic volatility model decomposes the log range of each exchange rate into two independent latent factors, which could be interpreted as the underlying currency specific components. Owing to the empirical normality of the logarithmic range measure the model can be estimated conveniently with the standard Kalman filter methodology. Our results show that our model fits the exchange rate data quite well. Exchange rate news seems to be currency specific and allows identification of currency contributions to both exchange rate levels and exchange rate volatilities.

Technology Trajectories and the Selection of Optimal R&D Project Sequences

Given a set of R&D projects drawing on the same underlying technology, a technology trajectory refers to the order in which projects are executed. Due to their technological interdependence, the successful execution of one project can increase a firms technological capability, and help to efficiently and effectively develop other projects from this set. In this paper, we present a model for determining the optimal sequence for performing such projects. Based on Huchzermeier and Lochs real-option value model, we demonstrate that accounting for interproject learning and discount rates has: 1) a positive effect on the maximum option value that different project sequences can achieve; and 2) the maximum value of the technology trajectory is particularly sensitive to the selection of the first project.

Estimating the preferences of central bankers : an analysis of four voting records

This paper analyzes the voting records of four central banks (Sweden, Hungary, Poland and the Czech Republic) with spatial models of voting. We infer the policy preferences of the monetary policy committee members and use these to analyze the evolution in preferences over time and the differences in preferences between member types and the position of the Governor in different monetary policy committees.

International Portfolio Choice

The allocation of securities in an investor’s portfolio is one of the oldest and most investigated problems in modern finance. Most financial studies that address the portfolio allocation problem focus on the issue of determining what the optimal allocation should be given a predefined set of securities and a predefined objective function. From a practitioner’s point of view, the resulting allocations may differ considerably from the existing portfolio allocations. It is well known that the computed optimal allocations are not very stable. See, for example, Best and Grauer (1991) and Black and Litterman (1992), who show that a small change in the mean of an asset return will have a huge impact on the optimal allocation of the portfolio but not on its performance. Therefore, a practitioner may be very cautious in deciding to follow the computed optimal allocations.

Hawks and Doves at the FOMC

In this paper we estimate ideal points of Bank Presidents and Board Governors at the FOMC. We use stated preferences from FOMC transcripts and estimate a hierarchical spatial voting model. We find a clear difference between the average Board Governor and Bank President. We find little evidence for difference in ideal points according to the appointing president in case of Bank Governors. Similarly career background has no clear effect on the ideal points. We find that the median ideal point at the FOMC has been fairly stable over our sample period (1989-2007) emphasizing the lack of a political appointment channel. We also show that there was considerable variation in the median ideal point of Bank Presidents and Board Governors, but that these seem to cancel each other out. Also the dispersion of opinions (the spread between the lowest and highest ideal point) varies over time, suggestion variation in agreement at the FOMC.