Academic Study

Construction Of the Implied Volatility Smile
Even extremely liquid markets, as the market for European style options on equity indexes, sometimes fail to provide sufficient data for pricing its options, as an example particular options might not be liquid enough. We are investigating an extension of a well-known and widely spread "market-based" Vanna-Volga method, which not only allows to retrieve reasonable estimates for option premiums, but also to determine consistent implied volatilities easily. The theoretical results are then analyzed using the daily settlement prices of the Dow Jones EURO STOXX 50 call options traded at Eurex. Introducing a stochastic volatility model, we were also able to deliver an explanation for the formulas, which were previously heuristically justified merely by formal expansion of the option premium by Itô.

Country versus Sector Rotation after the Introduction of the European Monetary Union (EMU)
The introduction of the European monetary union (EMU) led to a convergence of the participating countries in many ways. One particular aspect is the diversification potential among different financial markets. While during the 1990s country effects typically dominated industry effects in magnitude, more recent studies stress the importance of industry diversification when it comes to portfolio construction. We show the increasing correlations among countries\' equity market returns and the contemporaneous decrease in sector correlations and confirm the growing importance of industry effects by applying a bootstrapping method. Supported by this finding we implement momentum strategies based on countries and industries, respectively, in order to compare their performance. Due to the better diversification potential, most of the sector models outperform the country frameworks on a risk adjusted basis.

Financial Market Models and Market Maker Spreads
In this thesis we analyse market maker quoting behaviour at Eurex. We will look at bid and ask prices on equity index options and try to find explanatory variables for the cross-sectional distribution of the spread, i.e. the difference between the ask and the bid price. In contrast to former studies we have had the opportunity to analyse the quoting behaviour of individual market makers. Hence we can identify and ignore unwanted side effects of market maker models. We could explain most of the cross-sectional distribution with a three factor model. However, the main influence was found to be different for each market maker. An analysis of three different market makers reveals the spread size between bid and ask prices of a call option strongly depends on a) holding risk, measured by squared delta; b) Liquidity, measured by the time to expiry and c) cost of a substitute for a call position, measured by the spread of an equivalent put option. Surprisingly there was no significant correlation between market maker spreads and volatility of volatility. The function of an exchange is to provide a suitable market making model to create an equilibrium between supply and demand thereby ensuring high liquidity and transparency. Understanding the driving factors of market makers\' spread sizes can offer guidance in how to set the minimum tick size or the maximum allowed spread size.

Eurex Derivative Products in Alternative Investment - The Case for Managed Futures
This report provides an update on the potential benefits of incorporating Eurex futures contracts in CTA programs. In a previous report it was shown that incorporating Eurex futures contracts in trendfollowing programs would have improved the performance of CTAs employing those trading techniques over the period 1992-2002. This report covers the period 1992-2005. Results show that the Eurex futures contracts continue to provide the benefits illustrated in the previous report. Results also show that these strategies would have improved returns and lowered volatility for an investor holding a typical stock/bond portfolio. Although global equity indexes are highly correlated the returns from momentum strategies employed in these markets are surprisingly different. In particular, a 40% allocation to Eurex futures contracts would have resulted in similar volatility levels as an equity portfolio with a 200 basis point increase in annualized returns.

Replicating Hedge Fund Returns Using Futures - A European Perspective
Hedge funds tend to put a lot of effort into generating their returns and charge substantial fees to do so. However, with the latest performance evaluation studies indicating that hedge fund performance is not truly superior (anymore), the question arises whether it is possible to generate similar, hedge fund-like, returns in a more mechanical way and with less effort. In other words, is it possible to design dynamic trading strategies, mechanically trading stocks, bonds, etc., that generate hedge fund-like returns? If such strategies indeed exist, then this would solve a respectable number of problems surrounding hedge fund investments and alternative investments in general, including the need for extensive due diligence, liquidity, capacity, transparency, style drift and regulatory problems, as well as excessive management fees. In this paper we develop and demonstrate the workings of a technique that allows the derivation of dynamic futures trading strategies, which generate returns with statistical properties similar to hedge funds. Trading nothing else than Eurex DAX 30 and Euro Bund futures, we show that this technique is not only capable of replicating fund of funds returns, but is equally capable of replicating individual hedge fund returns. Accurately replicating the risk-return profile, but sharing none of the drawbacks of real hedge funds, our synthetic hedge fund returns are a worthwhile alternative to direct hedge fund investment.

Volatility and its Measurements: The Design of a Volatility Index and the Execution of its Historical Time Series at the Deutsche Börse AG
In April 2005 Stoxx Limited, the Swiss Exchange and Deutsche Börse launched a new family of volatility indexes. To prepare for the launch of new derivative products based on these indexes Eurex strongly supported the development and performed the construction of the historical time series. In this thesis we outline various volatility concepts usable as an underlying and explain which one is most suitable for index construction and forms the basis of the new index family. We outline in detail the actual index construction algorithm and document how the historical time series were evaluated. Finally we perform a first analysis of the historical time series. This analysis can be used as a basis to both develop and understand new volatility derivatives at Eurex.

Portable Alpha and Portable Beta Strategies in the Euro Zone
In this paper, we show how portfolio managers in the Eurozone can benefit from using derivatives markets to actively manage their asset allocation decisions in a systematic manner. Using a robust econometric process based on a non-linear multi-factor thick and recursive modeling approach, we report statistically and economically significant evidence of predictability in Dow Jones EURO STOXX 50 excess return. These econometric forecasts can be turned into active portfolio decisions and implemented via Eurex equity index futures to generate active asset allocation portable alpha benefits. We also show that adding active sector rotation decisions to asset allocation decisions allows one to significantly lower the portfolio volatility as a result of the benefits of bet diversification. We finally explain how active portfolio managers can benefit from using suitably designed Eurex option strategies as portable beta vehicles. In particular, option portfolios can be used to enhance the performance of tactical asset allocation programs by consistently adding value during the periods of low volatility when timing strategies are known to perform rather poorly. (For the complete abstract please refer to the paper.)