Publications
1.- Uncovering the risk-return trade-off through ridge regressions
Co-authors: Nuria Alemany and Vicent Aragó
Finance Research Letters 71, 106420 (2025)
Abstract: Using ridge regressions, we introduce a novel methodology to estimate a time-varying version of the market risk-return trade-off. Our model improves available techniques since it allows for flexible patterns in the relationship and does not need a long span of data or additional state variables to accurately estimate the trade-off. We find that this relationship is positive during almost all the sample but it occasionally turns out negative during deep recessions. Our results may help solve the controversy in the previous literature. Investors, policymakers, and regulators must monitor this relationship to optimise investment, manage risks, and prevent financial instability.
2.- Contingent Claims and Hedging of Credit Risk with Equity Options
Co-author: Davide Avino
The Review of Asset Pricing Studies, 14(2), 310-348 (2024)
Abstract: Using contingent-claims valuation, we introduce novel hedge ratios for credit exposures using put options. Option hedge ratios are generally in line with the empirical sensitivities of credit spread changes to put option returns and, relative to stock hedge ratios, produce further reductions in volatility for a portfolio of North American firms. We show that option hedge ratios capture option-specific credit exposure related to the VIX index and the default spread, which is unaccounted for by Merton’s (1974) equity hedge ratios alone. Combining stocks and put options for credit risk hedging can be done effectively using the volatility smirk.
3.- The time-varying risk-return trade-off and its explanatory and predictive factors
Co-authors: Nuria Alemany and Vicent Aragó
North American Journal of Economics and Finance 68, 101943 (2023)
Abstract: We analyze the intertemporal dimension of the risk–return trade-off and determine the drivers that better explain and predict its evolution. To this end, we propose a novel estimate of the relationship between return and risk where we generate time variation in the trade-off without conditioning the estimates to any state variable. We compare this dynamic approach with time-invariant or state-dependent estimates and observe that our dynamic method reasonably aligns with the constant (state dependent) methods but it offers a much broader picture of the risk–return trade-off. We also link its evolution to a set of macroeconomic, systematic and sentiment or uncertainty risk factors. We find that the risk–return relationship is positive during expansionary periods but it decreases during recessionary periods where occasionally even turns out negative. Our main conclusions hold for the consideration of hedging components, different MV-GARCH models or window lengths and several proxies of market returns and risk.
4.- Revisiting the Silver Crisis
Co-authors: Don Bredin and Valerio Potì
Journal of Commodity Markets 30, 100228 (2023)
Abstract: This paper examines the Silver Crisis of the late 1970s, which resulted in a $150 million lawsuit against the Hunt Brothers. In August 1988, the Hunt Brothers were found guilty by a jury of conspiracy, manipulation, monopolization, racketeering and fraud. Using a behavioural model, we aim to quantify the extent of manipulation in the silver market during the 1970s and the 1980s, with a specific focus on the period leading up to the Silver Crisis. Our behavioural model takes account of the role of fundamentals, manipulation and speculation. Our results indicate very little evidence of manipulation in the silver market in the run up to the Silver Crisis. Both fundamentals and speculation dominate the silver market during our sample, with speculation particularly important in the latter half of the 1970s. The distinction between manipulation and speculation is critical. While manipulation forces prices away from their fundamental value, speculation does not. Speculators certainly aim to take advantage of price changes but the actions are fully rational and consistent with the fundamental value of silver.
5.- The non-linear trade-off between return and risk and its determinants
Co-author: John Cotter
Journal of Empirical Finance 67, 100-132 (2022)
Abstract: We estimate a discrete approximation of the risk-return trade-off for the US market by using the whole universe of stocks from July 1963 to September 2017. We find the relationship between return and risk to be time-varying and also dependent on the level of risk considered. The proposed positive trade-off is mainly observed during low volatility periods and when we move from low risk up to medium-high risk investments. However, the direction of the trade-off is inverted for the highest risk alternatives especially during high volatility periods. The temporal variation of the risk-return trade-off can be explained by a series of sentiment, macro, credit risk, liquidity and corporate variables. All these determinants suggest that the positive relationship between return and risk is more evident during periods where economic, financial and market conditions improve.
6.- Market risk aversion under volatility shifts: an experimental study
Co-authors: Vicent Arago, Ivan Barreda, Adriana Breaban and Juan-Carlos Matallin
International Review of Economics and Finance 80, 552-568 (2022)
Abstract: Previous financial literature has been concerned with the theoretical and empirical study of the risk-return trade-off and market risk aversion under different stock market volatility regimes. We propose an experimental research to isolate the relationship between volatility regimes and investors' behavior and explore the mechanism by which aggregated risk aversion is configured. We design a market in which the volatility of the fundamentals is controlled and exogenously manipulated and we analyze the behavior of participants in different volatility states. Participants have the opportunity to choose at given times whether they want to participate in the market or they prefer to perform a real effort task instead, this providing the means to enter or exit the market. Our results show how, during high-volatility periods, the market risk aversion decreases compared to low-volatility periods. We also observe that participants show a higher probability of exiting the risky market at the onset of high-volatility periods, though this effect decreases when the agent is less risk-averse. These results suggest that more risk-averse investors leave the risky market and less risk-averse investors continue trading during high volatility periods. However, trading activity in the market is not significantly altered by the change in fundamental volatility. Finally, we find that the individual risk aversion level of agents does not change during the experiment being the reduction in the market risk aversion during high volatility periods due to a participation effect.
7. Food prices, ethics and forms of speculation
Co-authors: Don Bredin and Valerio Potì
Journal of Business Ethics 179, 495-509 (2022)
Abstract: This paper examines the role of speculative motives in the determination of commodity prices and specifically food related commodity prices. The motivation for this study is the considerable flow of funds into commodities, the widespread view that the process of financialization has led to greater levels of speculation and that speculation is the primary cause of regular spikes in food prices since the turn of the century. We consider two forms of short-term trading, a biasing influence (Manipulators) and a correcting influence (Speculators), relative to the fundamental price. While both forms of short-term trading are relevant, they are small in terms of their influence on overall prices. We do however find some evidence of an increased role being played by Manipulators during the period most associated with financialization.
8. On the stationarity of futures hedge ratios
Co-authors: Stavros Degiannakis, Christos Floros and Dimitrios Vougas
Operational Research 22, 2281-2303 (2022)
Abstract: Stationarity of hedge ratios can be viewed as a first step for portfolio hedging since it represents that the sensitivity of spot and future returns follow a process whose main characteristics do not depend on time. However, we provide evidence that the hedge ratios of the main European stock indices are better described as a combination of two different mean-reverting stationary processes, which depend on the state of the market. Also, when analysing the dynamics of hedge ratios at intraday level, results display a similar picture suggesting that intraday dynamics of the hedge between spot and futures are driven mainly by market participants with similar perspectives of the investment horizon.
9. The distribution of index futures realised volatility under seasonality and microstructure noise
Co-authors: Nuria Alemany and Vicent Aragó
Economic Modelling 93, 398-414 (2020)
Abstract: Previous research documents that the distribution of realised volatility appears approximately log-normal. However, formal tests reject normality fairly convincingly, which may indicate intrinsic features in the intraday data series, namely, the presence of seasonal intraday patterns and microstructure noise. Because many models are based on a normality assumption, this must be verified in order to validate the results. We find departures from normality due to the seasonal and noise components of intraday data, such that, after controlling for both features, the volatility estimates follow a log-normal distribution. Our results reveal that failing to account for these market imperfections can have important implications for analyses of volatility transmission and for investment and hedging decisions.
10. Optimal beats naive diversification: asset allocation using high-frequency data
Co-authors: Nuria Alemany and Vicent Aragó
Journal of Portfolio Management 47(1), 51-74 (2020)
Abstract: This article evaluates the usefulness of high-frequency data in optimal portfolio choice. The authors use a comprehensive list of major stock indexes and different frequencies of observations. Furthermore, they consider the impact of economic cycles, microstructure noise, and seasonality on performance. Their results show the ability of high-frequency data–based strategies to beat both monthly and daily based strategies and the benchmark equally weighted portfolio, even in presence of transaction costs. The authors also find that the outperformance arises from the reduction in the estimation error of the covariance matrix, which offsets the increase in transaction costs.
Co-authors: Nuria Alemany and Vicent Aragó
International Review of Economics and Finance 68, 269-280 (2020)
Abstract: This paper analyzes the impact of arbitrage opportunity changes on the price discovery process between the DAX30 index and the DAX30 index future within a short time scale. To this end, we use 5-min data, regime-switching models and the regime-dependent impulse response function. The results unveil the presence of nonlinearities in the cointegrating vector and the shortcomings of relying on linear assumptions. We also find that the presence of arbitrage opportunities alters the nature of the lead-lag dynamics: the more arbitrage opportunities, the greater the leading role of the futures market and the more pronounced the impact of unexpected shocks on prices.
12. The influence of intraday seasonality on volatility transmission pattern
Co-authors: Nuria Alemany and Vicent Aragó
Quantitative Finance 19(7), 1179-1197 (2019)
Abstract: Using data on a five-minute interval basis, this article analyses the effects of intraday seasonality on volatility transmission between the spot and futures markets of the CAC40, DAX30 and FTSE100. Remarkable differences in the impulse response analysis and in the dynamic and directional measurement of volatility spillovers are encountered depending on whether the intraday periodic component is considered. Thus, the convenience of removing intraday seasonality seems to be critical to reduce the risk of spurious causality when employing high-frequency data in volatility transmission. Moreover, the impact of market microstructure noise seems negligible when using an optimal frequency of observations.
13. Asset allocation with correlation: a composite trade-off
Co-authors: Rachel Carroll, Thomas Conlon and John Cotter
European Journal of Operational Research 262(3), 1164-1180 (2017)
Abstract: We assess the ability of minimum-variance portfolio allocation strategies accounting for time-varying correlation between assets to provide performance benefits relative to an equally-weighted portfolio. Prior to transaction costs correlation-based strategies emphatically outperform the equally-weighted benchmark. This finding is strongest for short horizon correlation forecasts and attributed to dynamic correlation as opposed to variance forecasts. Thus, estimation error is not found to be the primary obstacle to successful portfolio optimization. Rather, frequent rebalancing and associated transaction costs pose a significant challenge. Limiting portfolio turnover through short-selling restrictions and greater rebalancing error tolerance results in regular outperformance of the correlation-based strategies even for large transaction costs. Taken together, these findings provide evidence of a trade-off between optimal portfolio performance, forecasting horizon, rebalancing frequency and transaction costs.
14. Volatility, Trading Volume and Open Interest in Futures Markets
Co-authors: Christos Floros
International Journal of Managerial Finance 12(5), 629-653 (2016)
Abstract: This paper examines the effect of trading volume and open interest on volatility of futures markets. Our sampe includes daily data from 36 international futures markets (Currencies, Commodities, Stock Indices, Interest Rates and Bons) and covers the period 1997-2012. Using a two-stage estimation methodology we find that: (a) market depth may have an effect on the volatility of futures markets but this effect depends on the type of contracts, and (b) there is evidence of a positive contemporeneous relationship between trading volume and futures volatility for most futures contracts. Impulse-response function also show that trading volume has a more relevant role in explaining volatility than open interest.
15. Re-examining the risk-return relationship in Europe: linear or non-linear trade-off
Co-authors: Christos Floros and Vicent Aragó
Journal of Empirical Finance 28, 60-77 (2014)
Abstract: This paper analyzes the risk–return trade-off in Europe using recent data from 11 European stock markets. After relaxing the linear assumptions in the risk–return relationship by introducing a new approach that considers the current state of the market, we obtain significant evidence for a positive risk–return trade-off for low volatility states. However, this finding is reduced or even non-significant during periods of high volatility. Maintaining the linear assumption over the risk–return trade-off leads to non-significant estimations for all cases. These results are robust across countries despite the conditional volatility model used. These results also demonstrate that the inconclusive results in previous studies may be due to strong linear assumptions when modeling the risk–return trade-off. This previous research fails to uncover the global behavior of the relationship between return and risk.
16. Calendar anomalies in cash and stock index futures: International evidence
Co-author: Christos Floros
Economic Modelling 37, 216-223 (2014)
Abstract: This paper examines calendar anomalies (day-of-the-week and monthly seasonal effects) in cash and stock index futures returns. We consider daily data from FTSE100 (UK), FTSE/ASE-20 (Greece), S&P500 (US) and Nasdaq100 (US) spot and future indexes over the period 2004–2011. We employ a Regime-Switching specification which allows us to distinguish between different regimes corresponding to high and low volatile periods. The results show differences in the seasonal patterns in cash and futures indexes due to the existence of basis risk. Calendar effects are also conditioned to the market situation. During a low volatile situation these calendar effects tend to be positive, but these effects turn negative if themarket is under a high volatile period. These findings are recommended to financial risk managers dealing with futures markets.
17. The role of volatility regimes on volatility transmission patterns
Co-author: Nikos Nomikos
Quantitative Finance 14(1), 1-13 (2014)
Abstract: This paper investigates volatility transmission patterns between US and Eurozone stock markets differentiating between low and high volatility periods which tend to be related with international crisis. Our approach let us distinguish the spill-over intensities between markets in calm and 10 crisis periods and it also tests for a potential increase of market co-movements during these periods of market jitters. State-dependent volatility impulse-response functions are also introduced considering different responses of stock markets during the detected high and low volatility periods. The results show that both the spill-over intensities and conditional correlation increase in times of market instability.
Co-author: Vicent Aragó
The Journal of Futures Markets 34(4), 374-398 (2014)
Abstract: This study estimates linear and nonlinear GARCH models to find optimal hedge ratios with futures contracts for some of the main European stock indexes. By introducing nonlinearities through a regime‐switching model, we can obtain more efficient hedge ratios and superior hedging performance in both an in‐sample and an out‐sample analysis compared to the other methodologies (constant hedge ratios and linear GARCH). Moreover, nonlinear models also reflect the different patterns followed by the dynamic relationship between the volatility of spot and futures returns during low‐ and high‐volatility periods.
19. The risk-return trade-off in Europe: A temporal and cross-sectional analysis
Co-author: Vicent Aragó
Economic Computation and Economic Cybernetics Studies and Research 3/2012, 183-195 (2012)
Abstract: This paper analyzes the risk-return trade-off in European equities considering both temporal and cross-sectional dimensions. We introduce not only the market portfolio but also 15 industry portfolios comprising the entire market. The consideration of this pooled analysis (temporal and cross-sectional) let us obtain a positive and significant relationship between return and risk supporting the doctrine of the mainstream in the field. This result is even more evident when the estimation is conditioned on the main crises periods highlighting that the estimated risk-aversion parameter is higher in boom periods than in recession periods, reflecting a procyclical risk aversion in the investor profile.
20. The risk return trade-off in Emerging Markets
Emerging Markets Finance and Trade 48 (6), 107-129 (2012)
Abstract: This paper studies the risk-return trade-off in some of the main emerging stock markets in the world. Although previous studies on emerging markets were not able to show a positive and significant trade-off, favorable evidence can be obtained if a nonlinear framework between return and risk is considered. Using fifteen years of weekly data observations for twenty-five emerging markets Morgan Stanley Capital International indexes in a regime-switching GARCH framework, the author obtains favorable evidence for most of the emerging markets during low volatility periods, but not for periods of financial turmoil or using the traditional linear GARCH‑M approach.
21. Sudden changes in variance and time-varying hedge ratios
Co-authors: Vicent Aragó
European Journal of Operational Research 215, 393-403 (2010)
Abstract: This paper analyzes the influence of sudden changes in the unconditional volatility on the estimation and forecast of volatility and its impact on futures hedging strategies. We employ several multivariate GARCH models to estimate the optimal hedge ratios for the Spanish stock market including in each one some well-known patterns that may affect volatility forecasts (asymmetry and sudden changes). The main empirical results show that more complex models including sudden changes in volatility outperform the simpler models in hedging effectiveness both with in-sample and out-of-sample analysis. However, the evidence is stronger when the loss distribution tail is used as a measure for the effectiveness (Value at Risk (VaR) and Expected Shortfall (ES)) suggesting that traditional measures based on the variance of the hedged portfolio should be used with caution.
Working Papers
1.- Commodity Pricing: Evidence from Rational and Behavioral Models with Don Bredin and Valerio Potì
Abstract: In this paper, we study commodity pricing. To explain commodity prices and return volatility, we consider both a classical fundamental-based model with a rational representative agent and a behavioral extension with heterogeneous agents. We formally examine the role of speculators, in particular in relation to the super cycle in commodities and the time period most associated with the so-called financialization of commodities. We examine a total of 15 commodities covering agriculture, softs, energy and metals and a sample where possible covers the period from 1959 to 2017. In all cases, especially in the final part of the sample period, we reject the restrictions associated with the rational representative agent model. Our behavioral model, which includes heterogenous investors and horizons performs much better and in particular during the commodity super cycle and the recent period of financialization of commodities.
2.- Is naïve asset allocation always preferable? with Thomas Conlon, John Cotter and Iason Kynigakis
Abstract: Challenges to the empirical implementation of portfolio optimization abound, leading to a recent focus upon the naïve equally weighted portfolio as asset allocation benchmark. In this paper, we extend the performance analysis of the naïve allocation approach to encompass data both within and across asset classes (equity, bond, commodities and real-estate). Our assessment combines tail-risk measures with more typical risk-adjusted returns after accounting for transaction costs. When allocating across asset classes, we provide strong evidence that minimum-variance portfolios provide better risk-adjusted returns and reduced tail risk. In contrast, when allocating within asset classes, limited evidence for outperformance is found for optimal portfolios consisting of bonds. We attribute these findings to the level of systematic risk in the asset universe, which is high when allocating within asset classes and varies for cross-asset portfolios.
3.- Energy commodity pricing with Don Bredin and Valerio Potì
Abstract: In this paper, we study energy commodity pricing. To explain energy prices and their volatility, we consider both a classical fundamental-based model with a rational representative agent and a behavioral extension with heterogeneous agents. We formally examine the role of short-run motivated investors and distinguish between rational short-term investors (rational speculators) and irrational short-term investors (contrarian speculators). We examine the case of natural gas, heating oil and crude oil. In all cases, we reject the restrictions associated with the classical rational representative agent model. Our behavioral model, which augments the fundamentals-based investor with short-run focused investors, who differ in terms of rationality and/or horizons, performs much better. Our behavioral model also provides the opportunity to examine the impact of financialization on our chosen energy commodities.
4.- The ethics of finance with Don Bredin and Valerio Potì
Abstract: This paper examines the ethics of financial trading behaviour. Our motivation is to consider MacIntyre’s claim regarding non-virtuous trading behaviour and evaluate its merits empirically using a behavioural model and industry trading data. We place special emphasis on the heterogeneity of traders and use this to identify a suitable empirical distinction to determine the ethics of traders. We evaluate traders during the recent period of financialization as well as periods of high geopolitical risk. Most importantly, we focus on financial trading of essential food commodities to truly isolate non-virtuous behaviour. We find that there is consistent empirical evidence in favour of MacIntyre’s claim of non-virtuous trading. Our study adds to the developing literature on the ethics of finance and formally introduces an empirical evaluation of ethical exposure.