International Journal of Financial Engineering

The global crisis and increased competition have become increasingly essential issues in the risk and capital concern of banks. This study delves the effect of development indicators and market competition over the Asian banking industry. The robust generalized methods of moments (GMM) and two-stage least square (TSLS) estimated results of 191 Asian banks for 2000–2014 depict the significant impact of development indicators and competition over risk and capital of Asian banks. The findings of the study also show the substantial positive effect of inflations in regulatory capital, whereas the risk of banks is significantly reduced in the economic progression. Increase risk level act as a striking force of capital escalation which is consistent with the Basel accord and capitalized banks provokes managerial efficiency in managing risk than low capitalized counterparts.

In this paper, we propose a novel numerical approach for option pricing with the combination of the MC (Monte Carlo) simulation and the PDE (partial differential equation) approach. Our motivation originates from the fact that within a finite life time of an option contract, the underlying price as well as the range of volatility are expected to vary within a relatively small region centered around the current value of the underlying and the volatility and hence there is no need to compute option prices for the underlying and the volatility values beyond this region. Thus, our hybrid approach takes the advantage of both the MC simulation and PDE approach to form an approach that takes the MC simulation as a special case with the region being extremely small and the PDE approach as another special case with the region being extremely large. Through numerical experiments, we demonstrate that such a hybrid approach enhances computational efficiency, while maintaining the same level of accuracy when either the MC simulation or the PDE approach is used alone for the option prices computed within a suitably chosen interested region.

Motivated by the Basel III requirement we analyze an optimal Capital Adequacy Ratio subject to foreclosure risk exposure. We assume that the banker invests in treasuries, a stock index and a loan portfolio, where he/she wishes to maximize his/her expected utility of terminal wealth by selecting optimal investment and risk control strategies. The dynamics of the stock index and the banker’s risk exposure towards foreclosure is modeled as two independent compensated pure jump Lévy Processes. By applying the martingale approach we obtain a closed form solution for this optimization problem under a quadratic utility function. A negative correlation between the banker’s foreclosure risk and the price dynamics of stock index will result in a reduced amount invested in stock index fund while a positive correlation between the banker’s foreclosure risk and the price dynamics of stock index will increase the amount invested in stock index fund.

In Zhong (2018), LIBOR market model with multiplicative basis, International Journal of Financial Engineering, 5(2), we proposed a LIBOR market model with multiplicative basis, namely, the LMM-MB model, to model the joint evolution of the LIBOR rates and the OIS forward rates. This model leads to tractable pricing formulas for the standard interest rate derivatives such as the (vanilla) caplet, swaption and futures. In this paper, we study the pricing of some non-standard interest rate derivatives under the LMM-MB model, specifically the in-arrears (IA) cap and the ratchet cap. Similar to the vanilla caplet, we show that the pricing of the IA caplet can be readily computed by a proper integral of real-valued functions. We then derive an analytical approximation for the ratchet cap. In the case of non-zero spread, the ratchet cap can be approximated by using a two-dimensional fast Fourier transform method. In the case of zero spread, the ratchet cap can be computed from a proper integral of a single variable function. Numerical results reveal a good match of our close-form formulas with the Monte Carlo simulation method.

Within the setup of continuous-time semimartingale financial markets, we show that a multiprior Gilboa–Schmeidler minimax expected utility maximizer forms a portfolio consisting only of the riskless asset if and only if among the investor’s priors there exists a probability measure under which all admissible wealth processes are supermartingales. Furthermore, we show that under a certain attainability condition (which is always valid in finite or complete markets) this is also equivalent to the existence of an equivalent (local) martingale measure among the investor’s priors. As an example, we generalize a no betting result due to Dow and Werlang.

This paper examines the effect of corporate governance and earnings management on the value relevance of accounting information. Using data collected from the annual reports of non-financial companies listed in Pakistan Stock Exchange, it is concluded that earnings and book value are value relevant. The value relevance of earnings decreases while the value relevance of book value increases for the firms engaged in the earnings management. On the contrary, good corporate governance practices have a positive impact on the value relevance of earnings as well as the book value. Firm-specific characteristics enhance the predictive power of the model by more than 14%. A robustness test was carried out for alternative measures of earnings management. For this purpose, first performance-matched discretionary accruals were calculated following Kothari et al. (2005). Second, short-term accruals (DeChow, 1994), long-term accruals (Teoh et al., 1998b) and total accruals (Whelan, 2004), are calculated to analyze the effect on the value relevance of earnings and book value. The results support our null hypothesis.

In this paper, we employ the Least-Squares Monte-Carlo (LSM) algorithm regarding three discretization schemes, namely, the Euler–Maruyama discretization scheme, the Milstein scheme and the Quadratic Exponential (QE) scheme to price the multiple assets American put option under the Heston stochastic volatility model. Some numerical results are presented to demonstrate the effectiveness of the proposed methods.

We study the problem of dynamically trading a pair of futures contracts. We consider a two-factor mean-reverting model, where the spot price tends to evolve around its stochastic equilibrium that is also mean-reverting. We derive the futures price dynamics and determine the optimal futures trading strategy by solving a utility maximization problem. By analyzing the associated Hamilton–Jacobi–Bellman equation, we solve the utility maximization explicitly and provide the optimal trading strategies in closed form. Our strategies are applied to volatility (VIX) futures trading, and illustrated in a series of numerical examples.

Black–Scholes partial differential equation (PDE) is one of the most famous equations in mathematical finance and financial industry. In this study, numerical solution analysis is done for Black–Scholes PDE using finite element method with linear approach and finite difference methods. The numerical solutions are compared with Black–Scholes formula for option pricing. The numerical errors are determined for the finite element and finite difference applications to Black–Scholes PDE. We examine the error behavior and find the source of the corresponding errors under various market situations.

This paper proposed a method to control the weighted average price of manufacturer sales. The study of the posed problem is necessary to hedge manufacturer profits from price slumps in commodity markets. The elaborated method is applied to managing the trading process on real world commodity exchanges to prove its effectiveness.

In this paper, we develop an exact and explicit (model-independent) Taylor series representation of the implied volatility based on the novel applications of an extended Faà di Bruno formula under the operator calculus setting, and the Lagrange inversion theorem. We rigorously establish that our formula converges to the true implied volatility as the truncation order increases. Numerical examples illustrate the remarkable accuracy and efficiency of the formula. The formula distinguishes from previous literature as it converges to the true exact implied volatility, is a closed-form formula whose coefficients are explicitly determined and do not involve numerical iterations.