Global Business&Economic Review-Anthology 2002,371 (2002)
Using insights from real option theory, Abid (2001) developed a new financial instrument that he ... more Using insights from real option theory, Abid (2001) developed a new financial instrument that he called Zero inflation and interest credit opportunity (ZICO) where time is bartered and derived a series of models to value the payoffs of the ZICO’s buyer and seller.
ZICO is defined as a contract by which an investor lends funds to another investor for a certain predetermined period and acquires the right to borrow from the second investor the
same amount of funds and for the same length of time. To value the payoffs of the ZICO buyer, Abid (2001) considered three states of nature determined by the regularity of
investment opportunities. The first model explains how the one-ZICO period can be stated as two sub-periods of time referenced by three points of time. Each sub-period is governed by a set of investment opportunities entirely described by different rates of return. The ZICO buyer
lends funds to the ZICO seller for the first time sub-period and postpone his investment decision for the second ZICO sub-period. At the end of the first sub-period the ZICO seller
reimburses the borrowed funds and lends the same amount to the ZICO buyer for the same length of time. At the end of the second sub-period, which corresponds to the expiration date
of the ZICO contract, the ZICO buyer reimburses the funds he has borrowed. At this stage the
positions of the buyer and the seller are symmetric and ZICO may be seen as a zero sum game. For the payoffs of the buyer and the seller to be equal to zero, the expected return in the
second sub-period must be equal to the half of the expected return in the first sub-period. The second model is derived when the offered investment opportunities are not regular. In that case it is up to the buyer to invest in the second sub-period and wait for only the first subperiod or to continue lending and by the way continue postponing his investment waiting for the opportune moment to invest. The third model is set when investment opportunities are regular with an option to reinvest the payoff of the preceding ZICO contract (ZICO rollingover). The aim of this paper it to extend the discrete ZICO model to continuous time with stochastic returns. The ZICO two sub-periods are decomposed in infinitesimal periods. Returns generated by the first and second ZICO sub-periods respectively are assumed following a Geometrical Brownian motion described by a stochastically differential equation:
The payoff of the ZICO buyer is non linear. It evolutes proportionally to time squared and the difference between twice the instantaneous mean second sub-period return and the instantaneous mean of the first sub-period return. As the difference increases as the payoff of
the ZICO seller decreases and it becomes difficult for him to honour his commitment by reimbursing the buyer at the end of the ZICO first sub-period and lending him the same amount of funds that he borrowed from the ZICO buyer at the beginning of the first subperiod.
In ZICO economy, selection between efficient and inefficient investment decisions is accelerated compared to the standard economy. Acceleration may be measured by the difference of the two instantaneous means’ return . The payoff of the ZICO buyer is generated according to simultaneous effect of half time squared and the difference between twice the
instantaneous mean return that occur in the second sub-period and the instantaneous mean return or opportunity cost in the first sub-period. As selection in the ZICO investmentfinancing strategy is function of time squared this may lead to risk default.
To manage the default risk, velocity variation of the payoff must be reduced. There is a probability that investors will be unable to satisfy some or all of the indenture requirement
so the risk default must be introduce in the initial model to add guarantee and prudence to the fulfilment of the ZICO contract. The idea is to slow down the time quadratic evolution of the
investor’s payoff. To dissipate the velocity of payoff changes we introduce a guarantee term proportional to the return generated in the first ZICO sub-period.
The default risk is defined in the first ZICO sub-period. This risk is materialized by the fact
that the payoff of the seller is a quadratic function of time and if it is negative the seller go bankrupt. The guarantee mechanism allow to assess instantaneously the welfare of the seller as a measure of his ability to satisfy his agreement. With guarantee, return is no longer a linearly increasing function of time but it can be stated as a function that does not change for long term. Return is governed by a function that admit an asymptote determined by the instantaneous mean return over the grantee coefficient.
Interest Credit Opportunity (ZICO) where time is bartered and he derived a series of models to va... more Interest Credit Opportunity (ZICO) where time is bartered and he derived a series of models to value ZICO's buyer and seller payo¤s . In this paper we develop continuoustime ZICO models when returns ‡uctuates stochastically with and without grantee machanisim. Returns generated by the …rst and second ZICO sub-periods are assumed to vary according to a geometric Brownian motion described by a stochastic di¤erential equation. ZICO buyer payo¤s are found to evolve proportionally to time squared by the di¤erence between twice the instantaneous mean second sub-period return and the instantaneous mean …rst sub-period return or opportunity cost. In ZICO economy selection between e¢cient and ine¢cient investment decisions is accelerated compared to standard economy. Using Ornstein Uhlenbeck process, default risk in ZICO contracts is modeled by intorducing a garantee mechanisim against future loss.
This paper presents a new financial point of view to deal with financing capacity of a firm or an... more This paper presents a new financial point of view to deal with financing capacity of a firm or an individual investor to finance an investment program following a financial strategy based simultaneously on lending and waiting and borrowing and investing in a zero interest rate and zero inflation economy. Such strategy can be summarized by what I call Zero Inflation and Interest Credit Opportunity (ZICO). In the first section I define the strategy corresponding to the ZICO contract as a financial instrument. To model the payoffs and the returns of a ZICO contracts users, section two presents a simple mono-periodic ZICO contract and sections three and four give models when the offered opportunity sets are irregular, regular and with reinvestment and not reinvestment options respectively. The last section gives support to the usefulness and the benefits of using ZICO contracts in financing investment programs.
The research is partially supported by University of Sfax and Hong Kong Baptist University. The t... more The research is partially supported by University of Sfax and Hong Kong Baptist University. The third author would like to thank Robert B. Miller and Howard E. Thompson for their continuous guidance and encouragement.
This paper studies the forward premium anomaly in a multivariate nonlinear framework. We support ... more This paper studies the forward premium anomaly in a multivariate nonlinear framework. We support empirical evidence that deviation from uncovered interest rate parity is significantly nonlinear. This nonlinearity is consistent with theories of transaction costs and limits to speculation. We propose a regression model with logistic smoothed transition function allowing for two extreme regimes; A lower regime where forward premium is less than a threshold level and consistent with the forward premium anomaly. An outer regime where UIP has a high probability of holding. Our results reject the hypothesis of linearity in the relation between exchange rate dynamics and forward premium against non linear model. This model does not imply that UIP holds all the time. We show that when Sharpe ratio is lower than a threshold level, deviation from UIP appears significant and persistent. Values of Sharpe ratio must be large enough to attract speculative capital away from alternative trading strategies. We find that transition function of forward exchange rate has more important adjustment effect to the UIP condition compared to the transition function of spot exchange rate.
International Journal of Multicriteria Decision …, 2013
The aim of this paper is to develop an integrated multiple criteria decision making approach comb... more The aim of this paper is to develop an integrated multiple criteria decision making approach combining the analytic hierarchy process (AHP) and the goal programming (GP) model to study the impact of a mixture of investment barriers on international portfolio selection, and therefore the home bias puzzle from the viewpoint of G-7 investors over the period [2001][2002][2003][2004][2005][2006][2007][2008][2009]. The AHP is used to determine the suitable international equity portfolios with respect to seven barriers to international investment: Information costs, investor behavior (optimism or pessimism toward financial market returns), geographical distance, transaction costs, expropriation risk, financial market size, and capital flow restrictions. The GP model, incorporating the market weights of the maximum return, minimal variance, and AHP portfolios is formulated to determine the optimal international equity portfolios. The main results show that the AHP-GP optimal international portfolio weights are different from those predicted by the I-CAPM. Also, except for French and US investors, home bias values determined according to the AHP-GP portfolios are lower than those calculated on the basis of the value-weighted world market portfolio.
The Quarterly Review of Economics and Finance, 2009
The crude oil price is generally considered as the fundamental factor in the valuation of undevel... more The crude oil price is generally considered as the fundamental factor in the valuation of undeveloped reserves but it is not the unique one. Undeveloped field value also depends on the uncertainty relating to the convenience yield and the risk-free interest rate. The purpose of this paper is to decide on the best continuous-time stochastic models for these risk factors. The Generalized Method of Moments and the Maximum Likelihood Estimation are implemented to fit the parameters of continuous-time stochastic processes. The results of unit root tests without breaks reveal a mean reversion in convenience yield series. Multiple structural change tests show that the risk-free interest rate can be considered constant. The simulation of continuous-time stochastic processes and the mean error between the simulated prices and the market ones show that the Geometric Brownian Motion with jumps is the best model for the oil price compared to the other commonly used processes.
Journal of Computational and Applied Mathematics, 2009
In this paper, we evaluate a multi-stage information technology investment project, by implementi... more In this paper, we evaluate a multi-stage information technology investment project, by implementing and resolving Berk, Green and Naik’s (2004) model, which takes into account specific features of IT projects and considers the real option to suspend investment at each stage. We present a particular case of the model where the project value is the solution of an optimal control problem with a single state variable. In this case, the model is more intuitive and tractable. The case study confirms the practical potential of the model and highlights the importance of the real-option approach compared to classical discounted cash flow techniques in the valuation of IT projects.
Investment decisions by agribusiness firms are costly and subject to high volatility and uncertai... more Investment decisions by agribusiness firms are costly and subject to high volatility and uncertainty.
The volatility is a crucial variable in option pricing and hedging strategies. The aim of this pa... more The volatility is a crucial variable in option pricing and hedging strategies. The aim of this paper is to provide some initial evidence of the empirical relevance of genetic programming to volatility's forecasting. By using real data from S&P500 index options, the genetic programming's ability to forecast Black and Scholes-implied volatility is compared between time series samples and moneyness-time to maturity classes. Total and out-of-sample mean squared errors are used as forecasting's performance measures. Comparisons reveal that the time series model seems to be more accurate in forecasting-implied volatility than moneyness time to maturity models. Overall, results are strongly encouraging and suggest that the genetic programming approach works well in solving financial problems.
The aim of this paper is twofold; first we concentrate on the work of and Cox, Ingersoll and Ross... more The aim of this paper is twofold; first we concentrate on the work of and Cox, Ingersoll and Ross (1985). We examine and test empirically each model and discuss its performance in predicting the term structure of interest rates using a parametric estimating approach GMM (Generalized Moments Method). Second we estimate the term structure of interest rate dynamics using a nonparametric approach ANN (Artificial Neural Network). Two neural network models are performed. The first model uses spreads between interest rates of 10 different maturities as the only explanatory variable of interest rate changes. The second model introduces two factors, spreads and interest rates' levels. Using historical U.S. Treasury bill rates and Treasury bond yields, we compare the ability of each model to predict the term structure of interest rates. Data are daily and cover the period from 3 January 1995 to 29 December 2000. Results suggest that, neural network; and Cox, Ingersoll and Ross (1985) models generate different yield curves. Neural network models outperform the parametric standard models. The most successful forecast is obtained with two factors neural network model.
International Journal of Theoretical and Applied …, 2005
The aim of this paper is to study the impact of Stock returns volatility of reference entities on... more The aim of this paper is to study the impact of Stock returns volatility of reference entities on credit default swap rates using a new dataset from the Japanese market. The majority of empirical research suggests the inadequacy of multinormal distribution and then the failure of methods based on correlation for measuring the structure of dependency. Using a copula approach, we can model the different relationships that can exist in different ranges of behavior. We study the bivariate distributions of credit default swap rates and the measure of stock return volatility estimated with GARCH (1,1) and focus on one parameter Archimedean copula. Starting from the empirical rank correlation statistics (Kendall's tau and Spearman's rho), we estimate the parameter values of each copula function presented in our study. Then, we choose the appropriate Archimedean copula that better fit to our data. We emphasize the finding that pairs with higher rating present a weaker dependence coefficient and then, the impact of stock return volatility on credit default swap rates is higher for the lowest rating class.
Purpose – The aim of this paper is to study the impact of equity returns volatility of reference ... more Purpose – The aim of this paper is to study the impact of equity returns volatility of reference entities on credit-default swap rates using a new dataset from the Japanese market. Design/methodology/approach – Using a copula approach, the paper models the different relationships that can exist in different ranges of behavior. It studies the bivariate distributions of credit-default swap rates
International Journal of Theoretical and Applied …, 2006
The aim of this paper is to explain empirically the determinants of credit default swap rates usi... more The aim of this paper is to explain empirically the determinants of credit default swap rates using a linear regression. We document that the majority of variables, detected from the credit risk pricing theories, explain more than 60% of the total level of credit default swap. These theoretical variables are credit rating, maturity, riskless interest rate, slope of the yield curve and volatility of equities. The estimated coefficients for the majority of these variables are consistent with theory and they are significant both statistically and economically. We conclude that credit rating is the most determinant of credit default swap rates.
We thank Mustapha Nabli, Jeffery Nugent, Hadi Esfahani, Imed Limam, anonymous referee and the sem... more We thank Mustapha Nabli, Jeffery Nugent, Hadi Esfahani, Imed Limam, anonymous referee and the seminar participants at ERF 16th annual conference, for comments and suggestions. All errors, omissions and conclusions remain the sole responsibility of the authors.
Global Business&Economic Review-Anthology 2002,371 (2002)
Using insights from real option theory, Abid (2001) developed a new financial instrument that he ... more Using insights from real option theory, Abid (2001) developed a new financial instrument that he called Zero inflation and interest credit opportunity (ZICO) where time is bartered and derived a series of models to value the payoffs of the ZICO’s buyer and seller.
ZICO is defined as a contract by which an investor lends funds to another investor for a certain predetermined period and acquires the right to borrow from the second investor the
same amount of funds and for the same length of time. To value the payoffs of the ZICO buyer, Abid (2001) considered three states of nature determined by the regularity of
investment opportunities. The first model explains how the one-ZICO period can be stated as two sub-periods of time referenced by three points of time. Each sub-period is governed by a set of investment opportunities entirely described by different rates of return. The ZICO buyer
lends funds to the ZICO seller for the first time sub-period and postpone his investment decision for the second ZICO sub-period. At the end of the first sub-period the ZICO seller
reimburses the borrowed funds and lends the same amount to the ZICO buyer for the same length of time. At the end of the second sub-period, which corresponds to the expiration date
of the ZICO contract, the ZICO buyer reimburses the funds he has borrowed. At this stage the
positions of the buyer and the seller are symmetric and ZICO may be seen as a zero sum game. For the payoffs of the buyer and the seller to be equal to zero, the expected return in the
second sub-period must be equal to the half of the expected return in the first sub-period. The second model is derived when the offered investment opportunities are not regular. In that case it is up to the buyer to invest in the second sub-period and wait for only the first subperiod or to continue lending and by the way continue postponing his investment waiting for the opportune moment to invest. The third model is set when investment opportunities are regular with an option to reinvest the payoff of the preceding ZICO contract (ZICO rollingover). The aim of this paper it to extend the discrete ZICO model to continuous time with stochastic returns. The ZICO two sub-periods are decomposed in infinitesimal periods. Returns generated by the first and second ZICO sub-periods respectively are assumed following a Geometrical Brownian motion described by a stochastically differential equation:
The payoff of the ZICO buyer is non linear. It evolutes proportionally to time squared and the difference between twice the instantaneous mean second sub-period return and the instantaneous mean of the first sub-period return. As the difference increases as the payoff of
the ZICO seller decreases and it becomes difficult for him to honour his commitment by reimbursing the buyer at the end of the ZICO first sub-period and lending him the same amount of funds that he borrowed from the ZICO buyer at the beginning of the first subperiod.
In ZICO economy, selection between efficient and inefficient investment decisions is accelerated compared to the standard economy. Acceleration may be measured by the difference of the two instantaneous means’ return . The payoff of the ZICO buyer is generated according to simultaneous effect of half time squared and the difference between twice the
instantaneous mean return that occur in the second sub-period and the instantaneous mean return or opportunity cost in the first sub-period. As selection in the ZICO investmentfinancing strategy is function of time squared this may lead to risk default.
To manage the default risk, velocity variation of the payoff must be reduced. There is a probability that investors will be unable to satisfy some or all of the indenture requirement
so the risk default must be introduce in the initial model to add guarantee and prudence to the fulfilment of the ZICO contract. The idea is to slow down the time quadratic evolution of the
investor’s payoff. To dissipate the velocity of payoff changes we introduce a guarantee term proportional to the return generated in the first ZICO sub-period.
The default risk is defined in the first ZICO sub-period. This risk is materialized by the fact
that the payoff of the seller is a quadratic function of time and if it is negative the seller go bankrupt. The guarantee mechanism allow to assess instantaneously the welfare of the seller as a measure of his ability to satisfy his agreement. With guarantee, return is no longer a linearly increasing function of time but it can be stated as a function that does not change for long term. Return is governed by a function that admit an asymptote determined by the instantaneous mean return over the grantee coefficient.
Interest Credit Opportunity (ZICO) where time is bartered and he derived a series of models to va... more Interest Credit Opportunity (ZICO) where time is bartered and he derived a series of models to value ZICO's buyer and seller payo¤s . In this paper we develop continuoustime ZICO models when returns ‡uctuates stochastically with and without grantee machanisim. Returns generated by the …rst and second ZICO sub-periods are assumed to vary according to a geometric Brownian motion described by a stochastic di¤erential equation. ZICO buyer payo¤s are found to evolve proportionally to time squared by the di¤erence between twice the instantaneous mean second sub-period return and the instantaneous mean …rst sub-period return or opportunity cost. In ZICO economy selection between e¢cient and ine¢cient investment decisions is accelerated compared to standard economy. Using Ornstein Uhlenbeck process, default risk in ZICO contracts is modeled by intorducing a garantee mechanisim against future loss.
This paper presents a new financial point of view to deal with financing capacity of a firm or an... more This paper presents a new financial point of view to deal with financing capacity of a firm or an individual investor to finance an investment program following a financial strategy based simultaneously on lending and waiting and borrowing and investing in a zero interest rate and zero inflation economy. Such strategy can be summarized by what I call Zero Inflation and Interest Credit Opportunity (ZICO). In the first section I define the strategy corresponding to the ZICO contract as a financial instrument. To model the payoffs and the returns of a ZICO contracts users, section two presents a simple mono-periodic ZICO contract and sections three and four give models when the offered opportunity sets are irregular, regular and with reinvestment and not reinvestment options respectively. The last section gives support to the usefulness and the benefits of using ZICO contracts in financing investment programs.
The research is partially supported by University of Sfax and Hong Kong Baptist University. The t... more The research is partially supported by University of Sfax and Hong Kong Baptist University. The third author would like to thank Robert B. Miller and Howard E. Thompson for their continuous guidance and encouragement.
This paper studies the forward premium anomaly in a multivariate nonlinear framework. We support ... more This paper studies the forward premium anomaly in a multivariate nonlinear framework. We support empirical evidence that deviation from uncovered interest rate parity is significantly nonlinear. This nonlinearity is consistent with theories of transaction costs and limits to speculation. We propose a regression model with logistic smoothed transition function allowing for two extreme regimes; A lower regime where forward premium is less than a threshold level and consistent with the forward premium anomaly. An outer regime where UIP has a high probability of holding. Our results reject the hypothesis of linearity in the relation between exchange rate dynamics and forward premium against non linear model. This model does not imply that UIP holds all the time. We show that when Sharpe ratio is lower than a threshold level, deviation from UIP appears significant and persistent. Values of Sharpe ratio must be large enough to attract speculative capital away from alternative trading strategies. We find that transition function of forward exchange rate has more important adjustment effect to the UIP condition compared to the transition function of spot exchange rate.
International Journal of Multicriteria Decision …, 2013
The aim of this paper is to develop an integrated multiple criteria decision making approach comb... more The aim of this paper is to develop an integrated multiple criteria decision making approach combining the analytic hierarchy process (AHP) and the goal programming (GP) model to study the impact of a mixture of investment barriers on international portfolio selection, and therefore the home bias puzzle from the viewpoint of G-7 investors over the period [2001][2002][2003][2004][2005][2006][2007][2008][2009]. The AHP is used to determine the suitable international equity portfolios with respect to seven barriers to international investment: Information costs, investor behavior (optimism or pessimism toward financial market returns), geographical distance, transaction costs, expropriation risk, financial market size, and capital flow restrictions. The GP model, incorporating the market weights of the maximum return, minimal variance, and AHP portfolios is formulated to determine the optimal international equity portfolios. The main results show that the AHP-GP optimal international portfolio weights are different from those predicted by the I-CAPM. Also, except for French and US investors, home bias values determined according to the AHP-GP portfolios are lower than those calculated on the basis of the value-weighted world market portfolio.
The Quarterly Review of Economics and Finance, 2009
The crude oil price is generally considered as the fundamental factor in the valuation of undevel... more The crude oil price is generally considered as the fundamental factor in the valuation of undeveloped reserves but it is not the unique one. Undeveloped field value also depends on the uncertainty relating to the convenience yield and the risk-free interest rate. The purpose of this paper is to decide on the best continuous-time stochastic models for these risk factors. The Generalized Method of Moments and the Maximum Likelihood Estimation are implemented to fit the parameters of continuous-time stochastic processes. The results of unit root tests without breaks reveal a mean reversion in convenience yield series. Multiple structural change tests show that the risk-free interest rate can be considered constant. The simulation of continuous-time stochastic processes and the mean error between the simulated prices and the market ones show that the Geometric Brownian Motion with jumps is the best model for the oil price compared to the other commonly used processes.
Journal of Computational and Applied Mathematics, 2009
In this paper, we evaluate a multi-stage information technology investment project, by implementi... more In this paper, we evaluate a multi-stage information technology investment project, by implementing and resolving Berk, Green and Naik’s (2004) model, which takes into account specific features of IT projects and considers the real option to suspend investment at each stage. We present a particular case of the model where the project value is the solution of an optimal control problem with a single state variable. In this case, the model is more intuitive and tractable. The case study confirms the practical potential of the model and highlights the importance of the real-option approach compared to classical discounted cash flow techniques in the valuation of IT projects.
Investment decisions by agribusiness firms are costly and subject to high volatility and uncertai... more Investment decisions by agribusiness firms are costly and subject to high volatility and uncertainty.
The volatility is a crucial variable in option pricing and hedging strategies. The aim of this pa... more The volatility is a crucial variable in option pricing and hedging strategies. The aim of this paper is to provide some initial evidence of the empirical relevance of genetic programming to volatility's forecasting. By using real data from S&P500 index options, the genetic programming's ability to forecast Black and Scholes-implied volatility is compared between time series samples and moneyness-time to maturity classes. Total and out-of-sample mean squared errors are used as forecasting's performance measures. Comparisons reveal that the time series model seems to be more accurate in forecasting-implied volatility than moneyness time to maturity models. Overall, results are strongly encouraging and suggest that the genetic programming approach works well in solving financial problems.
The aim of this paper is twofold; first we concentrate on the work of and Cox, Ingersoll and Ross... more The aim of this paper is twofold; first we concentrate on the work of and Cox, Ingersoll and Ross (1985). We examine and test empirically each model and discuss its performance in predicting the term structure of interest rates using a parametric estimating approach GMM (Generalized Moments Method). Second we estimate the term structure of interest rate dynamics using a nonparametric approach ANN (Artificial Neural Network). Two neural network models are performed. The first model uses spreads between interest rates of 10 different maturities as the only explanatory variable of interest rate changes. The second model introduces two factors, spreads and interest rates' levels. Using historical U.S. Treasury bill rates and Treasury bond yields, we compare the ability of each model to predict the term structure of interest rates. Data are daily and cover the period from 3 January 1995 to 29 December 2000. Results suggest that, neural network; and Cox, Ingersoll and Ross (1985) models generate different yield curves. Neural network models outperform the parametric standard models. The most successful forecast is obtained with two factors neural network model.
International Journal of Theoretical and Applied …, 2005
The aim of this paper is to study the impact of Stock returns volatility of reference entities on... more The aim of this paper is to study the impact of Stock returns volatility of reference entities on credit default swap rates using a new dataset from the Japanese market. The majority of empirical research suggests the inadequacy of multinormal distribution and then the failure of methods based on correlation for measuring the structure of dependency. Using a copula approach, we can model the different relationships that can exist in different ranges of behavior. We study the bivariate distributions of credit default swap rates and the measure of stock return volatility estimated with GARCH (1,1) and focus on one parameter Archimedean copula. Starting from the empirical rank correlation statistics (Kendall's tau and Spearman's rho), we estimate the parameter values of each copula function presented in our study. Then, we choose the appropriate Archimedean copula that better fit to our data. We emphasize the finding that pairs with higher rating present a weaker dependence coefficient and then, the impact of stock return volatility on credit default swap rates is higher for the lowest rating class.
Purpose – The aim of this paper is to study the impact of equity returns volatility of reference ... more Purpose – The aim of this paper is to study the impact of equity returns volatility of reference entities on credit-default swap rates using a new dataset from the Japanese market. Design/methodology/approach – Using a copula approach, the paper models the different relationships that can exist in different ranges of behavior. It studies the bivariate distributions of credit-default swap rates
International Journal of Theoretical and Applied …, 2006
The aim of this paper is to explain empirically the determinants of credit default swap rates usi... more The aim of this paper is to explain empirically the determinants of credit default swap rates using a linear regression. We document that the majority of variables, detected from the credit risk pricing theories, explain more than 60% of the total level of credit default swap. These theoretical variables are credit rating, maturity, riskless interest rate, slope of the yield curve and volatility of equities. The estimated coefficients for the majority of these variables are consistent with theory and they are significant both statistically and economically. We conclude that credit rating is the most determinant of credit default swap rates.
We thank Mustapha Nabli, Jeffery Nugent, Hadi Esfahani, Imed Limam, anonymous referee and the sem... more We thank Mustapha Nabli, Jeffery Nugent, Hadi Esfahani, Imed Limam, anonymous referee and the seminar participants at ERF 16th annual conference, for comments and suggestions. All errors, omissions and conclusions remain the sole responsibility of the authors.
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Papers by Fathi Abid
ZICO is defined as a contract by which an investor lends funds to another investor for a certain predetermined period and acquires the right to borrow from the second investor the
same amount of funds and for the same length of time. To value the payoffs of the ZICO buyer, Abid (2001) considered three states of nature determined by the regularity of
investment opportunities. The first model explains how the one-ZICO period can be stated as two sub-periods of time referenced by three points of time. Each sub-period is governed by a set of investment opportunities entirely described by different rates of return. The ZICO buyer
lends funds to the ZICO seller for the first time sub-period and postpone his investment decision for the second ZICO sub-period. At the end of the first sub-period the ZICO seller
reimburses the borrowed funds and lends the same amount to the ZICO buyer for the same length of time. At the end of the second sub-period, which corresponds to the expiration date
of the ZICO contract, the ZICO buyer reimburses the funds he has borrowed. At this stage the
positions of the buyer and the seller are symmetric and ZICO may be seen as a zero sum game. For the payoffs of the buyer and the seller to be equal to zero, the expected return in the
second sub-period must be equal to the half of the expected return in the first sub-period. The second model is derived when the offered investment opportunities are not regular. In that case it is up to the buyer to invest in the second sub-period and wait for only the first subperiod or to continue lending and by the way continue postponing his investment waiting for the opportune moment to invest. The third model is set when investment opportunities are regular with an option to reinvest the payoff of the preceding ZICO contract (ZICO rollingover). The aim of this paper it to extend the discrete ZICO model to continuous time with stochastic returns. The ZICO two sub-periods are decomposed in infinitesimal periods. Returns generated by the first and second ZICO sub-periods respectively are assumed following a Geometrical Brownian motion described by a stochastically differential equation:
The payoff of the ZICO buyer is non linear. It evolutes proportionally to time squared and the difference between twice the instantaneous mean second sub-period return and the instantaneous mean of the first sub-period return. As the difference increases as the payoff of
the ZICO seller decreases and it becomes difficult for him to honour his commitment by reimbursing the buyer at the end of the ZICO first sub-period and lending him the same amount of funds that he borrowed from the ZICO buyer at the beginning of the first subperiod.
In ZICO economy, selection between efficient and inefficient investment decisions is accelerated compared to the standard economy. Acceleration may be measured by the difference of the two instantaneous means’ return . The payoff of the ZICO buyer is generated according to simultaneous effect of half time squared and the difference between twice the
instantaneous mean return that occur in the second sub-period and the instantaneous mean return or opportunity cost in the first sub-period. As selection in the ZICO investmentfinancing strategy is function of time squared this may lead to risk default.
To manage the default risk, velocity variation of the payoff must be reduced. There is a probability that investors will be unable to satisfy some or all of the indenture requirement
so the risk default must be introduce in the initial model to add guarantee and prudence to the fulfilment of the ZICO contract. The idea is to slow down the time quadratic evolution of the
investor’s payoff. To dissipate the velocity of payoff changes we introduce a guarantee term proportional to the return generated in the first ZICO sub-period.
The default risk is defined in the first ZICO sub-period. This risk is materialized by the fact
that the payoff of the seller is a quadratic function of time and if it is negative the seller go bankrupt. The guarantee mechanism allow to assess instantaneously the welfare of the seller as a measure of his ability to satisfy his agreement. With guarantee, return is no longer a linearly increasing function of time but it can be stated as a function that does not change for long term. Return is governed by a function that admit an asymptote determined by the instantaneous mean return over the grantee coefficient.
ZICO is defined as a contract by which an investor lends funds to another investor for a certain predetermined period and acquires the right to borrow from the second investor the
same amount of funds and for the same length of time. To value the payoffs of the ZICO buyer, Abid (2001) considered three states of nature determined by the regularity of
investment opportunities. The first model explains how the one-ZICO period can be stated as two sub-periods of time referenced by three points of time. Each sub-period is governed by a set of investment opportunities entirely described by different rates of return. The ZICO buyer
lends funds to the ZICO seller for the first time sub-period and postpone his investment decision for the second ZICO sub-period. At the end of the first sub-period the ZICO seller
reimburses the borrowed funds and lends the same amount to the ZICO buyer for the same length of time. At the end of the second sub-period, which corresponds to the expiration date
of the ZICO contract, the ZICO buyer reimburses the funds he has borrowed. At this stage the
positions of the buyer and the seller are symmetric and ZICO may be seen as a zero sum game. For the payoffs of the buyer and the seller to be equal to zero, the expected return in the
second sub-period must be equal to the half of the expected return in the first sub-period. The second model is derived when the offered investment opportunities are not regular. In that case it is up to the buyer to invest in the second sub-period and wait for only the first subperiod or to continue lending and by the way continue postponing his investment waiting for the opportune moment to invest. The third model is set when investment opportunities are regular with an option to reinvest the payoff of the preceding ZICO contract (ZICO rollingover). The aim of this paper it to extend the discrete ZICO model to continuous time with stochastic returns. The ZICO two sub-periods are decomposed in infinitesimal periods. Returns generated by the first and second ZICO sub-periods respectively are assumed following a Geometrical Brownian motion described by a stochastically differential equation:
The payoff of the ZICO buyer is non linear. It evolutes proportionally to time squared and the difference between twice the instantaneous mean second sub-period return and the instantaneous mean of the first sub-period return. As the difference increases as the payoff of
the ZICO seller decreases and it becomes difficult for him to honour his commitment by reimbursing the buyer at the end of the ZICO first sub-period and lending him the same amount of funds that he borrowed from the ZICO buyer at the beginning of the first subperiod.
In ZICO economy, selection between efficient and inefficient investment decisions is accelerated compared to the standard economy. Acceleration may be measured by the difference of the two instantaneous means’ return . The payoff of the ZICO buyer is generated according to simultaneous effect of half time squared and the difference between twice the
instantaneous mean return that occur in the second sub-period and the instantaneous mean return or opportunity cost in the first sub-period. As selection in the ZICO investmentfinancing strategy is function of time squared this may lead to risk default.
To manage the default risk, velocity variation of the payoff must be reduced. There is a probability that investors will be unable to satisfy some or all of the indenture requirement
so the risk default must be introduce in the initial model to add guarantee and prudence to the fulfilment of the ZICO contract. The idea is to slow down the time quadratic evolution of the
investor’s payoff. To dissipate the velocity of payoff changes we introduce a guarantee term proportional to the return generated in the first ZICO sub-period.
The default risk is defined in the first ZICO sub-period. This risk is materialized by the fact
that the payoff of the seller is a quadratic function of time and if it is negative the seller go bankrupt. The guarantee mechanism allow to assess instantaneously the welfare of the seller as a measure of his ability to satisfy his agreement. With guarantee, return is no longer a linearly increasing function of time but it can be stated as a function that does not change for long term. Return is governed by a function that admit an asymptote determined by the instantaneous mean return over the grantee coefficient.