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Jel Classification:C58 

Report
Global variance term premia and intermediary risk appetite

Sellers of variance swaps earn time-varying risk premia for their exposure to realized variance, the level of variance swap rates, and the slope of the variance swap curve. To measure risk premia, we estimate a dynamic term structure model that decomposes variance swap rates into expected variances and term premia. Empirically, we document a strong global factor structure in variance term premia across the U.S., U.K., Europe, and Japan. We further show that variance term premia are negatively correlated with the risk appetite of hedge funds, broker-dealers, and mutual funds. Our results ...
Staff Reports , Paper 789

Report
Equity Volatility Term Premia

This paper estimates the term-structure of volatility risk premia for the stock market. Realized variance term premia are increasing in systematic risk and predict variance swap returns. Implied volatility term premia are decreasing in risk initially, but then increase at a lag, predicting VIX futures returns. By modeling the logarithm of realized variance, the paper derives a closed-form relationship between the prices of variance swaps and VIX futures. The model provides accurate pricing and highlights periods of dislocation between the index options and VIX futures markets. Term premia ...
Staff Reports , Paper 867

Working Paper
Dynamic Factor Copula Models with Estimated Cluster Assignments

This paper proposes a dynamic multi-factor copula for use in high dimensional time series applications. A novel feature of our model is that the assignment of individual variables to groups is estimated from the data, rather than being pre-assigned using SIC industry codes, market capitalization ranks, or other ad hoc methods. We adapt the k-means clustering algorithm for use in our application and show that it has excellent finite-sample properties. Applying the new model to returns on 110 US equities, we find around 20 clusters to be optimal. In out-of-sample forecasts, we find that a model ...
Finance and Economics Discussion Series , Paper 2021-029

Working Paper
The role of jumps in volatility spillovers in foreign exchange markets: meteor shower and heat waves revisited

This paper extends the previous literature on geographic (heat waves) and intertemporal (meteor showers) foreign exchange volatility transmission to characterize the role of jumps and cross-rate propagation. We employ heterogeneous autoregressive (HAR) models to capture the quasi-long-memory properties of volatility and the Shapley-Owen R2 measure to quantify the contributions of components. We conclude that meteor showers are more influential than heat waves, that jumps play a modest but significant role in volatility transmission and that significant, bidirectional cross-rate volatility ...
Working Papers , Paper 2014-034

Working Paper
Undiversifying during Crises: Is It a Good Idea?

High levels of correlation among financial assets, as well as extreme losses, are typical during crisis periods. In such situations, quantitative asset allocation models are often not robust enough to deal with estimation errors and lead to identifying underperforming investment strategies. It is an open question if in such periods, it would be better to hold diversified portfolios, such as the equally weighted, rather than investing in few selected assets. In this paper, we show that alternative strategies developed by constraining the level of diversification of the portfolio, by means of a ...
Working Papers (Old Series) , Paper 1628

Working Paper
Closed-Form Estimation of Finite-Order ARCH Models: Asymptotic Theory and Finite-Sample Performance

Strong consistency and weak distributional convergence to highly non-Gaussian limits are established for closed-form, two stage least squares (TSLS) estimators for a class of ARCH(p) models. Conditions for these results include (relatively) mild moment existence criteria that are supported empirically by many (high frequency) financial returns. These conditions are not shared by competing closed-form estimators like OLS. Identification of these TSLS estimators depends on asymmetry, either in the model's rescaled errors or in the conditional variance function. Monte Carlo studies reveal TSLS ...
Finance and Economics Discussion Series , Paper 2016-083

Report
Liquidity and volatility in the U.S. treasury market

We model the joint dynamics of intraday liquidity, volume, and volatility in the U.S. Treasury market, especially through the 2007-09 financial crisis and around important economic announcements. Using various specifications based on Bauwens and Giot?s (2000) Log- ACD(1,1) model, we find that liquidity, volume, and volatility are highly persistent, with volatility having a lower short-term persistence than the other two. Market liquidity and volume are important to explaining volatility dynamics but not vice versa. In addition, market dynamics change during the financial crisis, with all ...
Staff Reports , Paper 590

Report
The Law of One Price in Equity Volatility Markets

This paper documents law of one price violations in equity volatility markets. While tightly linked by no-arbitrage restrictions, the prices of VIX futures exhibit significant deviations relative to their option-implied upper bounds. Static arbitrage opportunities occur when the prices of VIX futures violate their bounds. The deviations widen during periods of market stress and predict the returns of VIX futures. A relative value trading strategy based on the deviation measure earns a large Sharpe ratio and economically significant alpha-to-margin. There is evidence that systematic risk and ...
Staff Reports , Paper 953

Working Paper
Bayesian Estimation of Time-Changed Default Intensity Models

We estimate a reduced-form model of credit risk that incorporates stochastic volatility in default intensity via stochastic time-change. Our Bayesian MCMC estimation method overcomes nonlinearity in the measurement equation and state-dependent volatility in the state equation. We implement on firm-level time-series of CDS spreads, and find strong in-sample evidence of stochastic volatility in this market. Relative to the widely-used CIR model for the default intensity, we find that stochastic time-change offers modest benefit in fitting the cross-section of CDS spreads at each point in time, ...
Finance and Economics Discussion Series , Paper 2015-2

Working Paper
The Response of Stock Market Volatility to Futures-Based Measures of Monetary Policy Shocks

In this paper, we investigate the dynamic response of stock market volatility to changes in monetary policy. Using a vector autoregressive model, our findings reveal a significant and asymmetric response of stock returns and volatility to monetary policy shocks. Although the increase in the volatility risk premium, futures-trading volume, and leverage appear to contribute to a short-term increase in volatility, the longer-term dynamics of volatility are dominated by monetary policy's effect on fundamentals. The estimation results from a bivariate VAR-GARCH model suggest that the Fed does not ...
FRB Atlanta Working Paper , Paper 2014-14

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