Snorre Lindset

Understanding bull and bear ETFs

This paper analyzes leveraged exchange-traded funds (ETFs) with a particular focus on some of the early Norwegian ETFs. The funds use the futures markets to provide investors with 2 and−2 times the daily returns on the OBX index. First, we found that positive risk-free interest rates make the fund returns deviate from what is pictured by the providers. Secondly, we found that volatility can harm the investor returns. Thirdly, we found that the funds have fallen somewhat short of providing the pictured returns. Finally, we found that the positions taken in the futures markets are too small to obtain the pictured returns.

Hedge Fund Return Statistics 1994-2005

In this article we examine various statistical properties of several hedge fund style returns. We use hedge fund indices from CSBF/Tremont as well as global bonds and equity investment indices covering the period 1994–2005. We find that some of the hedge fund styles seem to have a higher mean return and a lower standard deviation than the equity market. We also find the index return distributions to be not normal and exhibit negative skewness and positive excess kurtosis for several styles. We also utilize stochastic dominance as a tool for ranking the best risk-adjusted investment style. Many hedge fund index returns have a high positive correlation with the stock market while most styles are nearly uncorrelated with the bond market. A high correlation with the equity market put the diversification effect of hedge funds into question

Credit Spreads and Incomplete Information

A new model is presented which produces credit spreads that do not converge to zero for short maturities. Our set-up includes incomplete, i.e., delayed and asymmetric information. When the financial market observes the companys earnings with a delay, the effect on both default policy and credit spreads is negligible, compared to the Leland (1994) model. When information is asymmetrically distributed between the management of the company and the financial market, short credit spreads do not converge to zero. This is result is similar to the Duffie and Lando (2001) model, although our simpler model improves some limitations in their set-up. Short interest rates from our model are used to illustrate effects similar to the dry-up in the interbank market experienced after the summer of 2007.

Optimal information acquisition for a linear quadratic control problem

This paper develops a generalization of the linear quadratic control problem with partial information. As in the standard partial information setting, it is assumed that the state variable is only observed with noise. The idea in this paper is that the information level may be chosen optimally. In real life information is costly to acquire. It is therefore a trade off between the costs of getting detailed information and the increased value this information gives. We believe that the technique we present should have potential for application within both economics and engineering.

Continuous Monitoring: Look Before You Leap

We present a model for pricing credit risk protection for a limited liability non-life insurance company. The protection is typically provided by a guaranty fund. In the case of continuous monitoring, i.e., where the market values of the companys assets and liabilities are continuously observable, and where the market values of assets and liabilities follow continuous processes, the regulators can liquidate the insurance company at the instant the market value of its assets equals the market value of its liabilities, implying that the credit protection is worthless. When jumps are included in the claims process, the protection provided by the guaranty fund has a strictly positive market value. We argue that the ability to continuously monitor the equity value of a company can be a new explanation for why jump processes may be important in models of credit risk.

Human capital investment and optimal portfolio choice

We analyze how an individual should optimally invest in human capital when he also has financial wealth. We treat the individuals possibilities to take more education as expansion options and apply real option analysis. In addition, we characterize the individuals optimal consumption strategy and portfolio weights. The individual has a demand for hedging financial risk, labor income risk, and also wage level risk.

A Generalization of the Formulas for Options on the Maximum or the Minimum of Several Assets

Abstract This paper generalizes the option on the maximum or the minimum of two assets (several assets) within a stochastic interest rate framework. A Gaussian model is used to describe the interest rates. Closed-form solutions for the market values are presented. The use of the options is illustrated with numerical examples.

Continuous Monitoring: Does Credit Risk Vanish?

We present a model for pricing credit risk protection for a limited liability nonlife insurance company. The protection is typically provided by a guaranty fund. In the case of continuous monitoring, i.e., where the market values of the company’s assets and liabilities are continuously observable, and where the market values of assets and liabilities follow continuous processes, regulators can liquidate the insurance company at the instant the market value of its assets equals the market value of its liabilities, implying that the credit protection is worthless. When jumps are included in the claims process, the protection provided by the guaranty fund has a strictly positive market value. The ability to continuously monitor asset prices with continuous sample paths eliminates economic losses from default. Our analysis suggests that economic losses from default stem from jumps in continuously observed asset prices and/or that asset prices are not continuously observed.

A Technique for Reducing Discretization Bias from Monte Carlo Simulations: Option Pricing under Stochastic Interest Rates

Abstract Control variates are often used to reduce variability in Monte Carlo estimates and their effectiveness is traditionally measured by the so-called speed-up factor. The main objective of this paper is to demonstrate that a control variate can also be applied to reduce the bias stemming from the discretization of the state variable dynamics. This is particularly valuable when stochastic interest rate models are discretized, since bias reduction through more grid points is computationally expensive.

Bank Debt Regulations and Instruments: Implications for Bank Capital and Bond Risk

We study how optimal bank capital and bond risk are influenced by deposit insurance, implicit guarantees, depositor preference, asset encumbrance, and bail-in resolution frameworks. We find that these features of bank financing change the optimal amount of bank capital. The net effect on bond debt risk and valuation is small, while the effects on shareholder value and public sector liability value are significant. A gap between optimal capital and required capital represents a cost to shareholders and increases the risk of regulatory arbitrage. Based on a small sample of European banks, we find support for the central model predictions.