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Keywords:term structure 

Horizon-Dependent Risk Aversion and the Timing and Pricing of Uncertainty

Inspired by experimental evidence, we amend the recursive utility model to let risk aversion decrease with the temporal horizon. Our pseudo-recursive preferences remain tractable and retain appealing features of the long-run risk framework, notably its success at explaining asset pricing moments. Calibrating the agents? preferences to explain the market returns observed in the data no longer implies an extreme preference for early resolutions of uncertainty and captures key puzzles in finance on the valuation and demand for risk at long maturities.
Staff Reports , Paper 703

Discussion Paper
Equity Volatility Term Premia

Investors can buy volatility hedges on the stock market using variance swaps or VIX futures. One motivation for hedging volatility is its negative relationship with the stock market. When volatility increases, stock returns tend to decline contemporaneously, a result known as the leverage effect. In this post, we measure the cost of volatility hedging by decomposing the prices of variance swaps and VIX futures into volatility forecasts and estimates of expected returns (“equity volatility term premia”) from January 1996 to June 2020.
Liberty Street Economics , Paper 20210203

The term structure of the price of variance risk

We estimate the term structure of the price of variance risk (PVR), which helps distinguish between competing asset-pricing theories. First, we measure the PVR as proportional to the Sharpe ratio of short-term holding returns of delta-neutral index straddles; second, we estimate the PVR in a Heston (1993) stochastic-volatility model. In both cases, the estimation is performed separately for different maturities. We find the PVR is negative and decreases in absolute value with maturity; it is more negative and its term structure is steeper when volatility is high. These findings are ...
Staff Reports , Paper 736

Discussion Paper
The Law of One Price in Equity Volatility Markets

Can option traders take a square root? Surprisingly, maybe not. This post shows that VIX futures prices exhibit significant deviations from their option-implied upper bounds—the square root of variance swap forward rates—thus violating the law of one price, a fundamental concept in economics and finance. The deviations widen during periods of market stress and predict the returns of VIX futures. Just as the stock market struggles with multiplication, the equity volatility market appears unable to take a square root at times.
Liberty Street Economics , Paper 20210201

Working Paper
Stock Market Fluctuations and the Term Structure

This paper uses the term structure of interest rates to explain the variations of stock prices and stock returns. It shows that interest rates have an important impact on stock returns, especially at long horizons. The hypothesis that expected stock returns move one-for-one with ex ante interest rates, which has been rejected strongly in other studies using short horizon data, is supported by long horizon data. The paper proposes, for the first time, a single measure---the present value of forward interest rates---to summarize the information of the term structure that is useful in ...
Finance and Economics Discussion Series , Paper 1996-03

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

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

Term structures of asset prices and returns

We explore the term structures of claims to a variety of cash flows: U.S. government bonds (claims to dollars), foreign government bonds (claims to foreign currency), inflation-adjusted bonds (claims to the price index), and equity (claims to future equity indexes or dividends). Average term structures reflect the dynamics of the dollar pricing kernel, of cash flow growth, and of their interaction. We use simple models to illustrate how relationships between the two components can deliver term structures with a wide range of levels and shapes.
Staff Reports , Paper 774

Anxiety in the face of risk

We model an ?anxious? agent as one who is more risk averse with respect to imminent risks than with respect to distant risks. Based on a utility function that captures individual subjects? behavior in experiments, we provide a tractable theory relaxing the restriction of constant risk aversion across horizons and show that it generates rich implications. We first apply the model to insurance markets and explain the high premia for short-horizon insurance. Then, we show that costly delegated portfolio management, investment advice, and withdrawal fees emerge as endogenous features and ...
Staff Reports , Paper 610

Discussion Paper
Are Stocks Cheap? A Review of the Evidence

We surveyed banks, we combed the academic literature, we asked economists at central banks. It turns out that most of their models predict that we will enjoy historically high excess returns for the S&P 500 for the next five years. But how do they reach this conclusion? Why is it that the equity premium is so high? And more importantly: Can we trust their models?
Liberty Street Economics , Paper 20130508


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