The empty creditor problem arises when a debtholder has obtained insurance against default but otherwise retains control rights in and outside bankruptcy. We analyze this problem from an ex ante and ...ex post perspective in a formal model of debt with limited commitment, by comparing contracting outcomes with and without insurance through credit default swaps (CDS). We show that CDS, and the empty creditors they give rise to, have important ex ante commitment benefits: By strengthening creditors' bargaining power, they raise the debtor's pledgeable income and help reduce the incidence of strategic default. However, we also show that lenders will over-insure in equilibrium, giving rise to an inefficiently high incidence of costly bankruptcy. We discuss a number of remedies that have been proposed to overcome the inefficiency resulting from excess insurance.
Rollover Risk and Market Freezes ACHARYA, VIRAL V.; GALE, DOUGLAS; YORULMAZER, TANJU
The Journal of finance (New York),
August 2011, Volume:
66, Issue:
4
Journal Article
Peer reviewed
Open access
The debt capacity of an asset is the maximum amount that can be borrowed using the asset as collateral. We model a sudden collapse in the debt capacity of good collateral. We assume short-term debt ...that must be frequently rolled over, a small transaction cost of selling collateral in the event of default, and a small probability of meeting a buy-to-hold investor. We then show that a small change in the asset's fundamental value can be associated with a catastrophic drop in the debt capacity, the kind of market freeze observed during the crisis of 2007 to 2008.
ABSTRACT Purpose — This paper explores how Islamic economics and finance, when developed as an embedded framework for regenerative development in line with maqāṣid al-Sharīʿah (the objectives of ...Islamic law), can facilitate the design of sustainable contracts and Islamic financial engineering. This framework provides a mechanism to achieve the paradigm shift advocated by Islamic finance scholars to accommodate the sustainability agenda into the practical applications of Islamic economics and finance. The paper specifically focuses on the Gulf Cooperation Council’s (GCC) economies. Design/Methodology/Approach — This study employs an analytical research approach to evaluate the compatibility of Islamic social and commercial finance with sustainability objectives. The analysis is primarily qualitative and relies on the One Earth Framework proposed by Simpson et al. (2021) to structure the assessment of opportunities and challenges related to sustainability that Islamic economics and finance in the GCC region can help address. Findings — The paper highlights the potential of Islamic economics and finance as an embedded framework to address sustainability challenges in the GCC countries. By examining the capacity of Islamic finance to accommodate sustainability pathways, it elucidates avenues for integrating sustainable practices within Islamic financial contracts and institutions. Originality/Value — One of the key contributions of this paper is the introduction and development of Islamic economics and finance as an embedded framework. This pioneering concept not only lays the groundwork for a practical mechanism but also signifies a fundamental step in realising the paradigm shift within Islamic finance. This transformative approach enhances the relevance and effectiveness of Islamic finance in fostering sustainability, marking a significant advancement in the field. Research Limitations — While the study provides valuable insights, it primarily follows an analytical approach and does not involve quantitative analysis. It serves as a starting point for further research on the integration of sustainability objectives in Islamic finance. Practical Implications — The paper suggests practical implications for Islamic finance stakeholders, highlighting the potential for sustainable contract design and financial engineering. Keywords — Islamic finance, Islamic financial engineering, Natural capital, Regenerative development, Sustainable contract design Article Classification — Conceptual paper
This article introduces a new nonparametric test to detect jump arrival times and realized jump sizes in asset prices up to the intra-day level. We demonstrate that the likelihood of ...misclassification of jumps becomes negligible when we use high-frequency returns. Using our test, we examine jump dynamics and their distributions in the U.S. equity markets. The results show that individual stock jumps are associated with prescheduled earnings announcements and other company-specific news events. Additionally, S&P 500 Index jumps are associated with general market news announcements. This suggests different pricing models for individual equity options versus index option.
State-of-the-art stochastic volatility models generate a "volatility smirk" that explains why out-of-the-money index puts have high prices relative to the Black-Scholes benchmark. These models also ...adequately explain how the volatility smirk moves up and down in response to changes in risk. However, the data indicate that the slope and the level of the smirk fluctuate largely independently. Although single-factor stochastic volatility models can capture the slope of the smirk, they cannot explain such largely independent fluctuations in its level and slope over time. We propose to model these movements using a two-factor stochastic volatility model. Because the factors have distinct correlations with market returns, and because the weights of the factors vary over time, the model generates stochastic correlation between volatility and stock returns. Besides providing more flexible modeling of the time variation in the smirk, the model also provides more flexible modeling of the volatility term structure. Our empirical results indicate that the model improves on the benchmark Heston stochastic volatility model by 24% in-sample and 23% out-of-sample. The better fit results from improvements in the modeling of the term structure dimension as well as the moneyness dimension.
Securitization for common health Ciardiello, Francesco; Di Lorenzo, Emilia; Menzietti, Massimiliano ...
Socio-economic planning sciences,
June 2024, 2024-06-00, Volume:
93
Journal Article
Peer reviewed
Securitization is the process of turning a financial asset, such as a loan or a mortgage, into a security that can be bought and sold on the market. Insurance-linked securities have been developed in ...order to foster the risk-transfer from insurers to capital market. In the context of pandemics or health crisis, securitization has been used to raise funds for crucial healthcare infrastructure and resources. However, securitization can also play a role in lowering infectious rates of pandemics as a part of risk mitigation strategies. Securitization can be engineered at higher standards and levels involving different actors. In the current paper, we propose an operational securitization mechanism based on the previous work by Di Lorenzo and Sibillo (2020) where a bond with coupon linked to the infection rate is introduced in order to reduce the risk exposure of an insurer offering health coverage. The combination of bond and health policies is structured in such a way to foster the economic operators (insureds, insurer, investors on capital market) to reduce the pandemic risk. It follows that companies might guarantee collective health for their workers if they subscribe insurance policies. Indeed, issuing such a bond on the market is challenging, due to poor market liquidity and, then, due to difficulties in pricing. In these regards, we value the pandemic-linked bond via an approach based on an inter-temporal CRRA utility function that, in its turn, determines a certain equivalent financial bond. The comparison values the pandemic-linked bond at varying with investors’ risk-aversion and sustainable-projects desirability. This provides an estimation of the risk-transfer cost for the insurers.
•A novel insurance method for mitigating the risk of health crisis•Approach of insurance as governance•The proposed insurance scheme includes securitization•Health spillovers on individuals who have not contributed to the whole welfare•Market-sustainability supported via a comparison with a certain bond
When ambiguity-averse investors process news of uncertain quality, they act as if they take a worst-case assessment of quality. As a result, they react more strongly to bad news than to good news. ...They also dislike assets for which information quality is poor, especially when the underlying fundamentals are volatile. These effects induce ambiguity premia that depend on idiosyncratic risk in fundamentals as well as skewness in returns. Moreover, shocks to information quality can have persistent negative effects on prices even if fundamentals do not change.
The Ascent of Market Efficiency weaves together historical narrative and quantitative bibliometric data to detail the path financial economists took in order to form one of the central theories of ...financial economics-the influential efficient-market hypothesis-which states that the behavior of financial markets is unpredictable. As the notorious quip goes, a blindfolded monkey would do better than a group of experts in selecting a portfolio of securities, simply by throwing darts at the financial pages of a newspaper. How did such a hypothesis come to be so influential in the field of financial economics? How did financial economists turn a lack of evidence about systematic patterns in the behavior of financial markets into a foundational approach to the study of finance? Each chapter in Simone Polillo's fascinating meld of economics, science, and sociology focuses on these questions, as well as on collaborative academic networks, and on the values and affects that kept the networks together as they struggled to define what the new field of financial economics should be about. In doing so, he introduces a new dimension-data analysis-to our understanding of the ways knowledge advances. There are patterns in the ways knowledge is produced, and The Ascent of Market Efficiency helps us make sense of these patterns by providing a general framework that can be applied equally to other social and human sciences.
The current research aims to develop a fast, stable and efficient numerical procedure for solving option pricing problems in jump–diffusion models. A backward partial integro-differential equation ...(PIDE) with diffusion and advection terms was investigated. Up to the best knowledge of the authors, some special numerical methods and strategies must be selected to solve advection–diffusion problems with reliable stability and accuracy. For the mentioned aims, the first- and second-order derivatives are approximated by integrated radial basis function based on partition of unity method. The IRBF-PU method is local mesh-free method that provides high order accurate result and is flexible for PDEs problems with sufficiently smooth initial conditions and also has a moderate condition number. In particular, we highlight European and American style put options, whose underlying asset follows a jump–diffusion model. For the distribution of the jumps, the Merton and Kou models are studied. Furthermore, the main model is classified in advection-x-diffusion category. As a result, we must increase the number of collocation points as well as the time steps to arrive at the final time. This procedure lengthens the execution time. To address this issue, we use the proper orthogonal decomposition (POD) method to reduce the size of the final algebraic system of equations. This numerical procedure is known as the proper orthogonal decomposition-IRBF-PU method (POD-IRBF-PU). The presented computational results (including the computation of option Greeks) and comparisons with other competing approaches suggest that the IRBF-PU and POD-IRBF-PU methods are efficient and reliable numerical methods to solve elliptic and parabolic PIDEs arising from applied areas such as financial engineering.
This study reconsiders the role of jumps for volatility forecasting by showing that jumps have a positive and mostly significant impact on future volatility. This result becomes apparent once ...volatility is separated into its continuous and discontinuous components using estimators which are not only consistent, but also scarcely plagued by small sample bias. With the aim of achieving this, we introduce the concept of threshold bipower variation, which is based on the joint use of bipower variation and threshold estimation. We show that its generalization (threshold multipower variation) admits a feasible central limit theorem in the presence of jumps and provides less biased estimates, with respect to the standard multipower variation, of the continuous quadratic variation in finite samples. We further provide a new test for jump detection which has substantially more power than tests based on multipower variation. Empirical analysis (on the S&P500 index, individual stocks and US bond yields) shows that the proposed techniques improve significantly the accuracy of volatility forecasts especially in periods following the occurrence of a jump.
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