Probability Distributions of Bull and Bear Market States

22.January 2021

Numerous academic papers have shown that the options markets are not only the place where the supply and demand for options meets. For example, they might point out to the smart money positioning, help to assess risk in the form of implied volatility, or be base of the well-known fear index VIX. Novel research of Bhansali and Holdom (2021), uses information embedded in options markets to construct a probability-weighted mixture of two distributions of bull and bear market states for the S&P 500 index. The results show that the implied return distributions drastically change switching from normal to stressed market states and vice versa. Moreover, the uncertainty in both distributions changes in the same fashion.

An excellent example is the shift of distributions before and after the recent US presidential election, which can be found below. Many have feared that if the democrat candidate Biden wins the elections, it would be a bad signal for the markets. However, after the uncertainty has passed, the fear has seemed to disappear. Additionally, the paper also shows how to use the bimodality in return distributions for the asset allocation using various utility functions. Allocations are made using a risky asset, risk-free and even options. Indeed, this research is worth reading. 

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Crypto Covered Interest Parity Deviations

15.January 2021

Bitcoin and other currencies are nowadays frequently discussed again. The debate has emerged mainly because of the strong uptrend in the Bitcoin price. In this blog post, we will leave the price patters to others. We will instead present interesting novel research connected to the well known theoretical model in the fiat currencies – the Covered Interest Rate Parity (CIP). If the CIP holds, interest rates and both the spot and forward rates of two countries should be in equilibrium. Novel research of Franz and Valentin (2020) examines the CIP in BTC/USD pair. The CIP theory states that there should be no arbitrage opportunities, but how the CIP holds in such a volatile market, where individual investors/traders seem to dominate? According to research, there were significant CIP deviations in the past, but it changed with the launch of BTC/USD futures in CME and high-frequency traders’ market entry. Moreover, the second event was much more successful in the reduction of deviations.

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Fiscal Stimulus Matters to Market

8.January 2021

Fiscal stimulus measures have become a hot topic in the financial markets. However, that is not surprising, since fiscal stimulus is a crucial government method to ease the pandemic crisis’s impacts. Therefore, the investors and market are very sensitive to this topic, and they react to the fiscal stimulus and any related news very sharply. While it is intuitive that the withdraw of the stimulus measures will negatively affect the markets and markets will fall, the magnitude of these falls is unknown. Novel research by Chan-Lau and Zhao (2020), quantifies the impacts of withdrawals and it’s effects on the stock markets worldwide. The reactions are especially negative if the fiscal stimulus is withdrawn “too soon”. According to the authors, too soon is when the number of daily COVID cases is high compared to the recent past.

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Top Ten Blog Posts on Quantpedia in 2020

1.January 2021

Once again, let us use the turn of the year for a short recapitulation of posts on our blog. Apart from other things we do (which we will summarize in our next blog post in a few days), we have published around over 50 short blog posts / recherches of academic papers on this blog during the last year. We want to use this opportunity to summarize 10 of them, which were the most popular (based on Google Analytics tool). Maybe you will be able to find something you have not read yet …

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Senators vs Santa’s Reindeer

29.December 2020

During the festive season, everything is more relaxed, and this week´s blog is no exception. The stock-picking abilities of animals are not the main research topic for most academics, yet the stock-picking skills, for example, of monkeys, were previously documented. To our best knowledge, the paper of Belmont et al. (2020) is the first that examines the stock-picking abilities of reindeer. Moreover, the performance of reindeer is compared to the US senators during 2020. Trading of US senators or congresspeople is particularly interesting since there are concerns about informed stock trading. Especially during the COVID pandemic, where the governments have a significant influence on the economies. The finding of the paper is that the performance of the senate is behind reindeer. However, the reindeer exhibit herding behavior and momentum preferences. Perhaps, their abilities should be examined more deeply during a more extended period.

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