Fractional Geometric Brownian Motion and Its Application to Futures Arbitrage #finance #trading #investing Geometric Brownian Motion (GBM) is the fundamental stochastic process used to model asset prices in continuous time. It serves as the foundation f…

Cointegration or Correlation, Which Method is Better for Pair Trading? #finance #trading #investing Pair trading or statistical arbitrage is a popular quantitative trading strategy. Basically, we choose a pair of assets for trading, and when the assets’…

How Retail Trading Affects Stock Market Volatility and Trading Strategies #finance #trading #investing Retail traders are often called noise, or uninformed traders as they contribute in large part to the noise in the stock market. The pandemic just acce…

Hedging Market Risks Using Volatility Estimators-Are Sophisticated Methods Better? #finance #trading #investing Previously, we elaborated on why hedging is an important tool for risk management. A recent paper [1] evaluated the hedging effectiveness of …

Identifying and Characterizing Market Regimes Across Asset Classes #finance #trading #investing Identifying market regimes is essential for understanding how risk, return, and volatility evolve across financial assets. In this edition, we examine two qu…

Pricing Options In The Real-World Measure #finance #trading #investing Option pricing is usually carried out in the risk-neutral world where the market participants are assumed to be indifferent between taking a certain payoff or investing in an asset w…

Do Covered Calls Deliver Superior Returns? #finance #trading #investing The covered call strategy is a popular and conservative options trading approach. It involves an investor holding a long position in an underlying asset, typically a stock, and then…

Impact of Artificial Intelligence on Financial Markets: a Quantitative and Qualitative Analysis #finance #trading #investing Artificial intelligence (AI) has become an integral part of modern finance, transforming how institutions analyze data, manage r…

Using a Parametric Implied Volatility Surface for Calculating Value At Risk #finance #trading #investing Value at Risk (VaR) is a widely used risk metric in finance, providing an estimate of the potential loss on a portfolio or investment over a specifi…

How Negative Oil Futures Price Impacts Production #finance #trading #investing A market shock, exemplified by the 1987 crash, denotes a sudden and severe disturbance in financial markets, leading to significant disruptions and abrupt changes in asset pr…

Can Trading Volume Predict Realized Volatility #finance #trading #investing Realized volatility (RV) is a measure that captures the degree of price fluctuation in a financial instrument over a specific period. This metric is valuable for investors and t…

The Role of Data in Financial Modeling and Risk Management #finance #trading #investing Much emphasis has been placed on developing accurate and robust financial models, whether for pricing, trading, or risk management. However, a crucial yet often over…

Momentum in the Option Market, Part 3 #finance #trading #investing In previous posts, we discussed the momentum phenomena in the options market. In essence, evidence suggests that delta-hedged straddle option positions exhibit momentum. This means that …

Return and Variance Risk Premia in the Bitcoin Market #finance #trading #investing The volatility risk premium (VRP) has been studied extensively in the literature, especially in equities. However, little work has been done in the crypto space. Referenc…

Using Hurst Exponent on the Volatility of Volatility Indices #finance #trading #investing A market regime refers to a distinct phase or state in financial markets characterized by certain prevailing conditions and dynamics. It describes the overall beha…

Predicting Covariance Matrices of Returns #finance #trading #investing Covariance plays an important role in portfolio construction as it measures the relationship between the returns of different assets in a portfolio. Understanding covariance helps in…

Trading Equity Indices Using Time Series Models #finance #trading #investing Time series models like ARIMA, or Autoregressive Integrated Moving Average, and VAR, or Vector Autoregression, are essential tools for forecasting sequential data points over t…

Incorporating Reflexivity into the Black–Scholes-Merton Framework #finance #trading #investing The Black-Scholes model (BSM) is a mathematical framework used to value options. Developed by Fischer Black, Myron Scholes, and Robert Merton in the early 197…

Volatility Risk Premium Across Different Asset Classes #finance #trading #investing The volatility risk premium has been studied extensively in the equity space, but less so in other asset classes. In this issue, we are going to examine the VRP across d…

Volatility Term Structures of Individual Stocks #finance #trading #investing In 1993, the Chicago Board Options Exchange (CBOE) launched the Volatility Index (VIX), which became a crucial gauge for expected short-term market volatility. It serves as the…

Fixed and Trailing Stop Losses in the Commodity Market #finance #trading #investing In a previous post, we discussed a theoretical model for studying the effectiveness of stop losses. In this post, we will present an empirical study of their efficacy in…

Bilateral Credit Value Adjustment With Default Correlation #finance #trading #investing Credit value adjustment (CVA) is a financial concept used to account for the potential loss in value of a portfolio due to counterparty credit risk. Essentially, CVA…

The Effectiveness of Dollar Cost Averaging Under Varying Market Conditions #finance #trading #investing Dollar-cost averaging (DCA) is an investment strategy where you invest a fixed amount of money at regular intervals, regardless of market conditions.…

Statistical Arbitrage in the Crude Oil Markets #finance #trading #investing Statistical arbitrage is a classic trading strategy, invented in the 1980s. We mostly see it being applied in the equity markets, but statistical arbitrage is not limited to equ…

Factor Model for Delta-Hedged Options Returns #finance #trading #investing Options are contracts that allow traders to buy or sell a security at a predetermined price. Options give the holder the right, but not the obligation, to buy (call option) or se…

When Trading Systems Break Down: Causes of Decay and Stop Criteria #finance #trading #investing A key challenge in system development is that trading performance often deteriorates after going live. In this issue, we look at why this happens by examinin…

The Volatility Risk Premium Around Macroeconomic Announcements #finance #trading #investing Markets are typically volatile, and price movements accelerate during macroeconomic announcements. We have discussed the macroeconomic announcement premium and t…

AI Aging: Model Quality Degradation #finance #trading #investing Artificial Intelligence (AI) and Machine Learning (ML) are two rapidly growing fields that have revolutionized the way we process and analyze data. AI refers to the development of computer…

How Credit Risks Affect Momentum Strategies Returns #finance #trading #investing Credit risk is the probability of loss from a borrower or counterparty. It is also known as default risk and refers to the potential that an entity may not be able to meet …

Do Commodities Lead the Equity Markets? #finance #trading #investing It is generally accepted that commodity prices can have an impact on equity markets, as the prices of commodities can affect the profitability and performance of companies in various s…

Diffusive Volatility and Jump Risks #finance #trading #investing Implied volatility is an estimation of the future volatility of a security’s price. It is calculated using an option-pricing model, such as the Black-Scholes model, as it takes into accoun…

Hedge Effectiveness Under a Four-State Regime Switching Model #finance #trading #investing Identifying market regimes is important for understanding shifts in risk, return, and volatility across financial assets. With the advancement of machine learning…

Volatility Targeting Across Asset Pricing Factors and Industry Portfolios #finance #trading #investing Position sizing is an important aspect of portfolio management, as it directly influences both risk and return. While investors can choose from a numb…

Lead-Lag Relationships Between Industries of Developed Countries #finance #trading #investing In the financial markets, a lead-lag relationship is a type of correlation in which the performance of one asset precedes that of another. This means that when…

An Option Pricing Model Based on Market Factors #finance #trading #investing In option pricing theory, the risk-neutral measure is a measure that allows for the valuation of financial instruments such as options. The risk-neutral measure is obtained by …

Comparative Analysis of Gold Forecasting Models: Statistical vs. Machine Learning Approaches #finance #trading #investing Gold is an important asset class, serving as both a store of value and a hedge against inflation and market uncertainty. Therefore,…

Gold and Low-Volatility Stocks as Diversifiers #finance #trading #investing Gold has long been regarded as a valuable diversification tool in investment portfolios due to its unique characteristics. As an asset class, gold has historically exhibited a l…

Validity of Research in Asset Management #finance #trading #investing Academic and practitioners’ literature is a source for many investment and trading ideas. However, it is often criticized for producing ideas that do not work in practice. A problem w…

Volatility, Correlations, and Causal Links in Cryptocurrency Markets #finance #trading #investing Analyzing volatilities, correlations, and lead–lag relationships across financial assets is important for portfolio and risk management. As cryptocurrencie…

Tail Risk Hedging Using Option Signals and Bond ETFs #finance #trading #investing Tail risk hedging plays a critical role in portfolio management. I discussed this topic in a previous edition. In this issue, I continue the discussion by presenting diffe…

Corporate Job Postings as Alternative Data #finance #trading #investing The last decade has seen the rise in popularity of alternative data in financial analysis. This data is generally defined as any information that is not typically used in financial …

Measuring Concentration Risk in Equity Markets Through HHI and Gini Metrics #finance #trading #investing Concentration risk arises when too much exposure is tied to a single firm, sector, or asset. If one company, or a handful of large players, becomes …

Butterfly Spreads for Harvesting Risk Premia #finance #trading #investing We have discussed trading strategies for harvesting volatility risk premium. In a similar context, Reference [1] examined the use of butterfly option positions as a trading strate…

Momentum Trading Strategies Across Capital Markets #finance #trading #investing Momentum trading is a popular investment strategy. Loosely speaking, it consists of periodically buying groups of outperforming stocks and selling non-winning stock portfoli…

Volatility of Volatility as a Risk Factor in Crypto Options #finance #trading #investing As cryptocurrencies become mainstream, liquidity in crypto derivatives such as perpetual futures and options is improving. They also attract more attention from res…

Integrating Structured and Unstructured Data with LLMs and RAG #finance #trading #investing Traditional quantitative methods often rely on structured data, such as time series. With the emergence of Large Language Models (LLMs), it is now possible to pr…

Stochastic Volatility Models for Capturing ETF Dynamics and Option Term Structures #finance #trading #investing The standard Black-Scholes-Merton model is valuable in both theory and practice. However, in certain situations, more advanced models are pre…

Using the Gaussian Mixture Models to Identify Market Regimes #finance #trading #investing Characterizing the market is an important step in trading system development. Currently, there exist a couple of approaches for identifying market regimes such as …

Pricing Asian Options on Low-Volatility Assets: Problem and Solution #finance #trading #investing An Asian option is a type of financial derivative contract commonly used in the world of finance. What sets it apart from traditional options, such as Euro…

Can Dividend Yield Predict Stock Returns? #finance #trading #investing Dividend yield is a financial metric that provides insight into the income generated by an investment in the form of dividends, relative to its market price. Expressed as a percentag…