Quant Finance Arxiv submissions 2022-05-30 - 2022-06-05
This is your weekly snap of quant finance submissions to the Arxiv. Papers are sorted in reverse chronological order of the original publication date. i.e. the newest papers are at the top, revisions are lower down the list.
If any paper take your fancy, you're encouraged to submit a link post to the subreddit, and start the discussion in the comments. Or in this thread, what do I care I'm not your boss.
Authors: Stavros Stavroyiannis
Categories: Statistical Finance
PDF: http://arxiv.org/pdf/2206.03278v1
Dates: originally published: 2022-06-03, updated: 2022-06-03
Summary: This paper examines the relationship between the price of the Dubai crude oil and the price of the US natural gas using an updated monthly dataset from 1992 to 2018, incorporating the latter events in the energy markets. After employing a variety of unit root and cointegration tests, the long-run relationship is examined via the autoregressive distributed lag (ARDL) cointegration technique, along with the Toda-Yamamoto (1995) causality test. Our results indicate that there is a long-run relationship with a unidirectional causality running from the Dubai crude oil market to the US natural gas market. A variety of post specification tests indicate that the selected ARDL model is well-specified, and the results of the Toda-Yamamoto approach via impulse response functions, forecast error variance decompositions, and historical decompositions with generalized weights, show that the Dubai crude oil price retains a positive relationship and affects the US natural gas price.
Authors: Man Yiu Tsang, Tony Sit, Hoi Ying Wong
Categories: Portfolio Management, Optimization and Control
PDF: http://arxiv.org/pdf/2206.01064v1
Dates: originally published: 2022-06-02, updated: 2022-06-02
Summary: The online portfolio selection (OLPS) problem differs from classical portfolio model problems, as it involves making sequential investment decisions. Many OLPS strategies described in the literature capture market movement based on various beliefs and are shown to be profitable. In this paper, we propose a robust optimization (RO)-based strategy that takes transaction costs into account. Moreover, unlike existing studies that calibrate model parameters from benchmark data sets, we develop a novel adaptive scheme that decides the parameters sequentially. With a wide range of parameters as input, our scheme captures market uptrend and protects against market downtrend while controlling trading frequency to avoid excessive transaction costs. We numerically demonstrate the advantages of our adaptive scheme against several benchmarks under various settings. Our adaptive scheme may also be useful in general sequential decision-making problems. Finally, we compare the performance of our strategy with that of existing OLPS strategies using both benchmark and newly collected data sets. Our strategy outperforms these existing OLPS strategies in terms of cumulative returns and competitive Sharpe ratios across diversified data sets, demonstrating its adaptability-driven superiority.
Authors: Ryo Sakai
Categories: General Finance
PDF: http://arxiv.org/pdf/2206.00640v1
Dates: originally published: 2022-06-01, updated: 2022-06-01
Summary: Activist investors have gradually become a catalyst for change in Japanese companies. This study examines the impact of activist board representation on firm performance in Japan. I focus on the only two Japanese companies with activist board representation: Kawasaki Kisen Kaisha, Ltd. ("Kawasaki") and Olympus Corporation ("Olympus"). Overall, I document significant benefits from the decision to engage with activists at these companies. The target companies experience greater short- and long-term abnormal stock returns following the activist engagement. Moreover, I show operational improvements as measured by return on assets and return on equity. Activist board members also associate with important changes in payout policy that help explain the positive stock returns. My findings support the notion that Japanese companies should consider engagements with activist investors to transform and improve their businesses. Such interactions can lead to innovative and forward-thinking policies that create value for Japanese businesses and their stakeholders.
Authors: Qiang Liu, Yingtao Luo, Shu Wu, Zhen Zhang, Xiangnan Yue, Hong Jin, Liang Wang
Categories: Statistical Finance
PDF: http://arxiv.org/pdf/2206.00568v1
Dates: originally published: 2022-06-01, updated: 2022-06-01
Summary: In financial credit scoring, loan applications may be approved or rejected. We can only observe default/non-default labels for approved samples but have no observations for rejected samples, which leads to missing-not-at-random selection bias. Machine learning models trained on such biased data are inevitably unreliable. In this work, we find that the default/non-default classification task and the rejection/approval classification task are highly correlated, according to both real-world data study and theoretical analysis. Consequently, the learning of default/non-default can benefit from rejection/approval. Accordingly, we for the first time propose to model the biased credit scoring data with Multi-Task Learning (MTL). Specifically, we propose a novel Reject-aware Multi-Task Network (RMT-Net), which learns the task weights that control the information sharing from the rejection/approval task to the default/non-default task by a gating network based on rejection probabilities. RMT-Net leverages the relation between the two tasks that the larger the rejection probability, the more the default/non-default task needs to learn from the rejection/approval task. Furthermore, we extend RMT-Net to RMT-Net++ for modeling scenarios with multiple rejection/approval strategies. Extensive experiments are conducted on several datasets, and strongly verifies the effectiveness of RMT-Net on both approved and rejected samples. In addition, RMT-Net++ further improves RMT-Net's performances.
Authors: Samuel N. Cohen, Christoph Reisinger, Sheng Wang
Categories: Risk Management, Probability, Computational Finance, Statistical Finance
PDF: http://arxiv.org/pdf/2205.15991v1
Dates: originally published: 2022-05-31, updated: 2022-05-31
Summary: We study the capability of arbitrage-free neural-SDE market models to yield effective strategies for hedging options. In particular, we derive sensitivity-based and minimum-variance-based hedging strategies using these models and examine their performance when applied to various option portfolios using real-world data. Through backtesting analysis over typical and stressed market periods, we show that neural-SDE market models achieve lower hedging errors than Black--Scholes delta and delta-vega hedging consistently over time, and are less sensitive to the tenor choice of hedging instruments. In addition, hedging using market models leads to similar performance to hedging using Heston models, while the former tends to be more robust during stressed market periods.
Authors: Yang Shen, Bin Zou
Categories: Mathematical Finance, Optimization and Control, Portfolio Management
PDF: http://arxiv.org/pdf/2205.15905v1
Dates: originally published: 2022-05-31, updated: 2022-05-31
Summary: We consider monotone mean-variance (MMV) portfolio selection problems with a conic convex constraint under diffusion models, and their counterpart problems under mean-variance (MV) preferences. We obtain the precommitted optimal strategies to both problems in closed form and find that they coincide, without and with the presence of the conic constraint. This result generalizes the equivalence between MMV and MV preferences from non-constrained cases to a specific constrained case. A comparison analysis reveals that the orthogonality property under the conic convex set is a key to ensuring the equivalence result.
Authors: Kevin Kamm, Michelle Muniz
Categories: Risk Management
PDF: http://arxiv.org/pdf/2205.15699v1
Dates: originally published: 2022-05-31, updated: 2022-05-31
Summary: In this paper, we introduce a novel methodology to model rating transitions with a stochastic process. To introduce stochastic processes, whose values are valid rating matrices, we noticed the geometric properties of stochastic matrices and its link to matrix Lie groups. We give a gentle introduction to this topic and demonstrate how It^o-SDEs in R will generate the desired model for rating transitions. To calibrate the rating model to historical data, we use a Deep-Neural-Network (DNN) called TimeGAN to learn the features of a time series of historical rating matrices. Then, we use this DNN to generate synthetic rating transition matrices. Afterwards, we fit the moments of the generated rating matrices and the rating process at specific time points, which results in a good fit. After calibration, we discuss the quality of the calibrated rating transition process by examining some properties that a time series of rating matrices should satisfy, and we will see that this geometric approach works very well.
Authors: Kiyoshi Kanazawa, Hideki Takayasu, Misako Takayasu
Categories: Trading and Market Microstructure, Statistical Mechanics, Physics and Society
PDF: http://arxiv.org/pdf/2205.15558v1
Dates: originally published: 2022-05-31, updated: 2022-05-31
Summary: The two-body stochastic dealer model is revisited to provide an exact solution to the average order-book profile using the kinetic approach. The dealer model is a microscopic financial model where individual traders make decisions on limit-order prices stochastically and then reach agreements on transactions. In the literature, this model was solved for several cases: an exact solution for two-body traders $N=2$ and a mean-field solution for many traders $N\gg 1$. Remarkably, while kinetic theory plays a significant role in the mean-field analysis for $N\gg 1$, its role is still elusive for the case of $N=2$. In this paper, we revisit the two-body dealer model $N=2$ to clarify the utility of the kinetic theory. We first derive the exact master-Liouville equations for the two-body dealer model by several methods. We next illustrate the physical picture of the master-Liouville equation from the viewpoint of the probability currents. The master-Liouville equations are then solved exactly to derive the order-book profile and the average transaction interval. Furthermore, we introduce a generalised two-body dealer model by incorporating interaction between traders via the market midprice and exactly solve the model within the kinetic framework. We finally confirm our exact solution by numerical simulations. This work provides a systematic mathematical basis for the econophysics model by developing better mathematical intuition.
Authors: Yanzhao Zou, Dorien Herremans
Categories: Statistical Finance
PDF: http://arxiv.org/pdf/2206.00648v1
Dates: originally published: 2022-05-30, updated: 2022-05-30
Summary: Bitcoin, with its ever-growing popularity, has demonstrated extreme price volatility since its origin. This volatility, together with its decentralised nature, make Bitcoin highly subjective to speculative trading as compared to more traditional assets. In this paper, we propose a multimodal model for predicting extreme price fluctuations. This model takes as input a variety of correlated assets, technical indicators, as well as Twitter content. In an in-depth study, we explore whether social media discussions from the general public on Bitcoin have predictive power for extreme price movements. A dataset of 5,000 tweets per day containing the keyword Bitcoin' was collected from 2015 to 2021. This dataset, called PreBit, is made available online. In our hybrid model, we use sentence-level FinBERT embeddings, pretrained on financial lexicons, so as to capture the full contents of the tweets and feed it to the model in an understandable way. By combining these embeddings with a Convolutional Neural Network, we built a predictive model for significant market movements. The final multimodal ensemble model includes this NLP model together with a model based on candlestick data, technical indicators and correlated asset prices. In an ablation study, we explore the contribution of the individual modalities. Finally, we propose and backtest a trading strategy based on the predictions of our models with varying prediction threshold and show that it can used to build a profitable trading strategy with a reduced risk over ahold' or moving average strategy.
Authors: Huifang Huang, Ting Gao, Yi Gui, Jin Guo, Peng Zhang
Categories: Mathematical Finance, Portfolio Management
PDF: http://arxiv.org/pdf/2205.15056v1
Dates: originally published: 2022-05-30, updated: 2022-05-30
Summary: Reinforcement learning (RL) is gaining attention by more and more researchers in quantitative finance as the agent-environment interaction framework is aligned with decision making process in many business problems. Most of the current financial applications using RL algorithms are based on model-free method, which still faces stability and adaptivity challenges. As lots of cutting-edge model-based reinforcement learning (MBRL) algorithms mature in applications such as video games or robotics, we design a new approach that leverages resistance and support (RS) level as regularization terms for action in MBRL, to improve the algorithm's efficiency and stability. From the experiment results, we can see RS level, as a market timing technique, enhances the performance of pure MBRL models in terms of various measurements and obtains better profit gain with less riskiness. Besides, our proposed method even resists big drop (less maximum drawdown) during COVID-19 pandemic period when the financial market got unpredictable crisis. Explanations on why control of resistance and support level can boost MBRL is also investigated through numerical experiments, such as loss of actor-critic network and prediction error of the transition dynamical model. It shows that RS indicators indeed help the MBRL algorithms to converge faster at early stage and obtain smaller critic loss as training episodes increase.
Authors: Estelle Sterrett, Waylon Jepsen, Evan Kim
Categories: Computational Finance, Pricing of Securities
PDF: http://arxiv.org/pdf/2205.09890v2
Dates: originally published: 2022-05-19, updated: 2022-06-02
Summary: The current design space of derivatives in Decentralized Finance (DeFi) relies heavily on oracle systems. Replicating market makers (RMMs) provide a mechanism for converting specific payoff functions to an associated Constant Function Market Makers (CFMMs). We leverage RMMs to replicate the approximate payoff of a Black-Scholes covered call option. RMM-01 is the first implementation of an on-chain expiring option mechanism that relies on arbitrage rather than an external oracle for price. We provide frameworks for derivative instruments and structured products achievable on-chain without relying on oracles. We construct long and binary options and briefly discuss perpetual covered call strategies commonly referred to as "theta vaults." Moreover, we introduce a procedure to eliminate liquidation risk in lending markets. The results suggest that CFMMs are essential for structured product design with minimized trust dependencies.
Authors: A. H. Nzokem, V. T. Montshiwa
Categories: Probability, Statistical Finance
PDF: http://arxiv.org/pdf/2205.00586v2
Dates: originally published: 2022-05-02, updated: 2022-06-04
Summary: The paper investigates the rich class of Generalized Tempered Stable distribution, an alternative to Normal distribution and the $\alpha$-Stable distribution for modelling asset return and many physical and economic systems. Firstly, we explore some important properties of the Generalized Tempered Stable (GTS) distribution. The theoretical tools developed are used to perform empirical analysis. The GTS distribution is fitted using S&P 500, SPY ETF and Bitcoin BTC. The Fractional Fourier Transform (FRFT) technique evaluates the probability density function and its derivatives in the maximum likelihood procedure. Based on the results from the statistical inference and the Kolmogorov-Smirnov (K-S) goodness-of-fit, the GTS distribution fits the underlying distribution of the SPY ETF return. The right side of the Bitcoin BTC return, and the left side of the S&P 500 return underlying distributions fit the Tempered Stable distribution; while the left side of the Bitcoin BTC return and the right side of the S&P 500 return underlying distributions are modelled by the compound Poisson process
Authors: Frido Rolloos
Categories: Pricing of Securities
PDF: http://arxiv.org/pdf/2205.05489v3
Dates: originally published: 2022-04-30, updated: 2022-05-31
Summary: Two novel closed-form formulas for the price of barrier options in stochastic volatility models with zero interest rate and dividend yield but nonzero correlation between the asset and its instantaneous volatility are derived. The first is a Hull and White type formula, and the second is a decomposition formula similar in form to the Al`os decomposition for vanilla options. A model-free approximation is also given.
Authors: Mathieu Rosenbaum, Jianfei Zhang
Categories: Mathematical Finance, Risk Management, Computational Finance, Pricing of Securities
PDF: http://arxiv.org/pdf/2107.01611v2
Dates: originally published: 2021-07-04, updated: 2022-05-30
Summary: The quadratic rough Heston model provides a natural way to encode Zumbach effect in the rough volatility paradigm. We apply multi-factor approximation and use deep learning methods to build an efficient calibration procedure for this model. We show that the model is able to reproduce very well both SPX and VIX implied volatilities. We typically obtain VIX option prices within the bid-ask spread and an excellent fit of the SPX at-the-money skew. Moreover, we also explain how to use the trained neural networks for hedging with instantaneous computation of hedging quantities.
Authors: Silvana M. Pesenti
Categories: Risk Management
PDF: http://arxiv.org/pdf/2107.01065v2
Dates: originally published: 2021-07-02, updated: 2022-05-31
Summary: We consider the problem where a modeller conducts sensitivity analysis of a model consisting of random input factors, a corresponding random output of interest, and a baseline probability measure. The modeller seeks to understand how the model (the distribution of the input factors as well as the output) changes under a stress on the output's distribution. Specifically, for a stress on the output random variable, we derive the unique stressed distribution of the output that is closest in the Wasserstein distance to the baseline output's distribution and satisfies the stress. We further derive the stressed model, including the stressed distribution of the inputs, which can be calculated in a numerically efficient way from a set of baseline Monte Carlo samples and which is implemented in the R package SWIM on CRAN. The proposed reverse sensitivity analysis framework is model-free and allows for stresses on the output such as (a) the mean and variance, (b) any distortion risk measure including the Value-at-Risk and Expected-Shortfall, and (c) expected utility type constraints, thus making the reverse sensitivity analysis framework suitable for risk models.
Authors: Laurence Carassus, Massinissa Ferhoune
Categories: Computational Finance, Pricing of Securities
PDF: http://arxiv.org/pdf/2105.08804v2
Dates: originally published: 2021-05-18, updated: 2022-05-30
Summary: In a context of illiquidity, the reservation price is a well-accepted alternative to the usual martingale approach which does not apply. However, this price is not closed and requires numerical methods such as Monte Carlo or polynomial approximations to evaluate it. We show that these methods can be inaccurate and propose a deterministic decomposition of the reservation price using the Lambert function. This decomposition allows us to perform an improved Monte Carlo method called LMC and to give deterministic approximations of the reservation price and of the optimal strategies based on the Lambert function. We also give an answer to the problem of selecting a hedging asset that minimizes the reservation price and also the cash invested. Our theoretical results are illustrated by numerical simulations.
Authors: Yerkin Kitapbayev, Scott Robertson
Categories: Risk Management, Pricing of Securities
PDF: http://arxiv.org/pdf/2005.03554v4
Dates: originally published: 2020-05-07, updated: 2022-05-31
Summary: We analyze recently proposed mortgage contracts that aim to eliminate selective borrower default when the loan balance exceeds the house price (the ``underwater'' effect). We show contracts that automatically reduce the outstanding balance in the event of house price decline remove the default incentive, but may induce prepayment in low price states. However, low state prepayments vanish if the benefit from home ownership is sufficiently high. We also show that capital gain sharing features, such as prepayment penalties in high house price states, are ineffective as they virtually eliminate prepayment. For observed foreclosure costs, we find that contracts with automatic balance adjustments become preferable to the traditional fixed-rate contracts at mortgage rate spreads between 20-50 basis points. We obtain these results for perpetual versions of the contracts using American options pricing methodology, in a continuous-time model with diffusive home prices. The contracts' values and optimal decision rules are associated with free boundary problems, which admit semi-explicit solutions.
Authors: Andrew Papanicolaou, Shiva Chandra
Categories: Trading and Market Microstructure, Portfolio Management
PDF: http://arxiv.org/pdf/1910.06463v4
Dates: originally published: 2019-10-14, updated: 2022-06-04
Summary: We present an expansion for portfolio optimization in the presence of small, instantaneous, quadratic transaction costs. Specifically, the magnitude of transaction costs has a coefficient that is of the order $\epsilon$ small, which leads to the optimization problem having an asymptotically-singular Hamilton-Jacobi-Bellman equation whose solution can be expanded in powers of $\sqrt\epsilon$. In this paper we derive explicit formulae for the first two terms of this expansion. Analysis and simulation are provided to show the behavior of this approximating solution.
Authors: Henryk Gzyl, Alfredo Rios
Categories: Portfolio Management
PDF: http://arxiv.org/pdf/1805.06345v3
Dates: originally published: 2018-05-16, updated: 2022-06-04
Summary: During the last few years, there has been an interest in comparing simple or heuristic procedures for portfolio selection, such as the naive, equal weights, portfolio choice, against more "sophisticated" portfolio choices, and in explaining why, in some cases, the heuristic choice seems to outperform the sophisticated choice. We believe that some of these results may be due to the comparison criterion used. It is the purpose of this note to analyze some ways of comparing the performance of portfolios. We begin by analyzing each criterion proposed on the market line, in which there is only one random return. Several possible comparisons between optimal portfolios and the naive portfolio are possible and easy to establish. Afterwards, we study the case in which there is no risk free asset. In this way, we believe some basic theoretical questions regarding why some portfolios may seem to outperform others can be clarified.
Authors: Manuel Lafond
Categories: Trading and Market Microstructure
PDF: http://arxiv.org/pdf/1605.04949v2
Dates: originally published: 2016-04-08, updated: 2022-06-02
Summary: Traders buy and sell financial instruments in hopes of making profit, and brokers are responsible for the transaction. There are several hypotheses and conspiracy theories arguing that in some situations, brokers want their traders to lose money. For instance, a broker may want to protect the positions of a privileged customer. Another example is that some brokers take positions opposite to their traders', in which case they make money whenever their traders lose money. These are reasons for which brokers might manipulate prices in order to maximize the losses of their traders. In this paper, our goal is to perform this shady task optimally -- or at least to check whether this can actually be done algorithmically. Assuming total control over the price of an asset (ignoring the usual aspects of finance such as market conditions, external influence or stochasticity), we show how in quadratic time, given a set of trades specified by a stop-loss and a take-profit price, a broker can find a maximum loss price movement. We also look at an online trade model where broker and trader exchange turns, each trying to make a profit. We show in which condition either side can make a profit, and that the best option for the trader is to never trade.
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