Paul Schneider
Bio Sketch: Paul Schneider graduated in 2006 from the University of Vienna with a PhD in finance. After a post-doctoral position in Vienna he joined the University of Warwick in 2008 as Assistant Professor. In January 2012 he joined the University of Lugano as Senior Assistant Professor in quantitative methods at the faculty of economics. Dr. Schneider’s research interests include asset pricing, financial econometrics, and statistical methods. His work has been published in the Journal of Financial Economics, Annals of Statistics, and the Journal of Econometrics, among other international journals.
Abstract: This paper generalizes risk premia to a definition capturing full market exposure, rather than just first moments. Corresponding excess returns are interpreted as the payoff to a likelihood ratio swap, a benchmark instrument with the worst possible Sharpe ratio. I establish a technique to operationalize the likelihood ratio swap with a time-series model and to replicate it through option portfolios and the underlying asset. The resulting trading strategy combines the predictive density of the model and the information contained in option prices to sell insurance on model risk. The Sharpe ratio of this insurance strategy provides an objective measure of predictability suited for model selection. In the S&P 500 market I find that neither stochastic volatility, nor valuation-based information improve predictability over a simple homoskedastic return model. I reveal a strong connection between flight-to-quality in crisis periods and the compensation for variance, skew and kurtosis risk.
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