Working papers 2006
Number 2006/01 - Prof. Roger Bowden and Jennifer Zhu
"Which are the world's wobbliest currencies? Reference rates and their variation."
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AbstractMeasuring country exchange rates relative to a common reference basket results in a set of no-arbitrage prices, unlike trade-weighted indexes, the usual method of comparing country exchange rate histories. The single degree of freedom involved can be resolved by drawing on required economic interpretations or uses. We use currency reference rates to examine the historical variability of different currencies over designated cyclical horizons. The temporal decompositions used are those privided by wavelet analysis, which is light on maintained assumptions about data generating processes. some countries, notably Japan and New Zealand do exhibit a powerful lbut irregular medium term cycle, while others are much more stable. Implications are examined for investment, hedging, monetary policy and common currency studies.
Number 2006/02 - Prof R Bowden, J Zhu and Dr Jin Seo Cho
"Knowing A Bit but Not Too Much: Incomplete Directional models and their use in Forecasting and Hedging"
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AbstractDirectional calls are often more successful than precise value prediction, particularly at certain times, when underlying fundamentals suggest a breakout from the stable range. We adapt the categorical directional framework implicit in binomial or trinominal step processes to establish nonhomogeneous multinomial directional probabilities over coarser time intervales and show how such frameworks can be used for forecasting the hedging, including dynamic persistence. Problems of signal compression and outcome definition can be addressed using methods analogous to neuronal nets and fuzzy membership functions. the methods are applied to derive forecasting and conditional hedge procedures for foreign exchange exposures.
Number 2006/03 - Prof R Bowden and Jennifer Zhu
"Beyond the short run: The longer time scale volatility of investment value"
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AbstractFund and other investments often exhibit longer run volatility associated with macroeconomic or other dynamics to an extent inconsistent with the efficient market accumulation model. Volatility and performance models or metrics based on one-period returns or simple extensions can fail to pick up this, resulting in suboptimal investment policies, or welfare losses if exit happens to be forced at the wrong time. We show how to use wavelet analysis to resolve problems of detection, attribution and welfare measurement, including assigning volatility metrics and path risk, while dynamic value at risk ideas can be applied to establish clearance points relatiave to any benchmark comparator path. Generalisations of the spectral utility function can guide investment policy or be used to design optimal portofolios. Band pass portfolios can be designed that smooth investor exposure to long or short run instabilities in investment value.
Number 2006/04 - Professor R Bowden
"Option value at risk and the value of the firm: Does it pay to hedge?"
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AbstractDecisions to modify the firm's natural exposure by using derivatives should be referenced back to the maximisation of corporate value. Every firm has a natural exposure to adversity, costs that typically start well in advance of bankruptcy. The implicit value of the resulting adversity or hazard options extends a long shadow over corporate value, even in beter states, and this is what hedging is designed to neutralise. The framework is used to integrate corporate value maximisation, value at risk and expected utility theory. Value at risk can be regarded as a socially imposed devise to neutralise the shareholders' limited liability exit option and will often result in over-hedging. It may be not optimal to hedge in adverse conditions: one should hedge the prospect but not the event. Modifiers such as leverage, exposure uncertainty, market incompleteness, competition and bank regulation can be explored within the same framework.