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Recent Research: Highlights from January 2011

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The StressVaR: A New Risk Concept for Extreme Risk and Fund Allocation.” The Journal of Alternative Investments (Winter 2011). Cyril Coste, Raphaël Douady, and Ilija I Zovko.

In this article the authors introduce an approach to risk estimation based on nonlinear factor–models—the “StressVaR” (SVaR). Developed to evaluate the risk of hedge funds, the SVaR appears to be applicable to a wide range of investments. The computation of the StressVaR is a three-step procedure whose main component is to use the fairly short and sparse history of the hedge fund returns to identify relevant risk factors among a very broad set of possible risk sources. This risk profile is obtained by calibrating a polymodel, which is a collection of nonlinear single-factor models, as opposed to a single multi-factor model. The authors then use the risk profile and the very long and rich history of the factors to assess the possible impact of known past crises on the funds, unveiling their hidden risks and so called “black swans.”


U.S. Exchange Auction Trends: Recent Opening and Closing Auction Behavior, and the Implications on Order Management Strategies.” The Journal of Trading (Winter 2011). Robert Kissell and Hans Lie.

The trends and trading styles around the exchanges’ opening auction (OPEN) and closing auction (CLOSE) volumes are evaluated over the period January 2009–June 2010. Kissell and Lie find that,overall, small-cap stocks have higher auction percentages than large-cap stocks;NYSE large-cap stocks have higher auction percentages (CLOSE% and OPEN%) than NASDAQ large-cap stocks, but NASDAQ small-cap stocks have higher CLOSE% and OPEN% than the NYSE; and no long-term trends in auction volumes or any seasonal patterns are uncovered. A day-of-week effect (Fridays), however, demonstrates a higher daily percentage of auction volumes than any other day of the week. Special event days, such as FOMC, triple witching, earnings, index changes,month and quarter end, before/after holidays, and early close days, are also evaluated. The authors find that triple witching days are associated with higher CLOSE% and OPEN%, and that the FOMC is associated with lower CLOSE% and OPEN%. The other special event days are associated with an increase in CLOSE% and a decrease in OPEN%, or vice versa; for example, index change days are associated with a much higher CLOSE%, but a much lower OPEN%. A correlation study between daily volumes and auction volumes and the percentages of daily and auction volumes shows that, as expected, a positive correlation between raw daily volumes and auction volumes exists, but a negative correlation between daily volumes and auction volume percentages is also present.


Dissecting Corporate Bond and CDS Spreads.” The Journal of Fixed Income (Winter 2011). Hai Lin, Sheen Liu, and Chunchi Wu.

In this article, the authors propose a new method to estimate the components of corporate bond and CDS spreads. They develop a CDS pricing model with default and nondefault factors and a corporate bond pricing model with default, tax, and liquidity factors using the reduced-form approach, and they jointly estimate parameters of both models from the pooled data. By formulating default intensity as a common factor in the prices of the CDS and reference bonds, the authors are able to identify the default and nondefault components of yield spreads more precisely. They find that, on average, the liquidity premium accounts for about 20–25% of corporate yield spreads across ratings and the size of the liquidity premium increases as the rating decreases. Furthermore, they find that the CDS spread contains a nontrivial nondefault component. Ignoring this component in the CDS spread thus results in a serious bias in the estimate of spread components when using the CDS information to aid in decomposition of corporate yield spreads.

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