Do Lead-Lag Effects Affect Derivative Pricing?

Abstract

The chosen parameter values are σ p 2 = σ s 2 = 0.3, a = 1, and ρ ps is either -1, -0.5, 0, or 0.5.. The current share price is always P(0) = 40, the current index level S(0) is either 40, 45, or 50, and the time to maturity is either one year, five years, or 10 years. Variances and covariance of finite holding-period returns are fixed at Var [∆p * ]/τ = 0.1456, Var [∆s * ]/τ = 0.1456, and Cov[∆p * , ∆s * ]/τ = 0.0728. This exhibit shows parameter estimates resulting from estimator (3), corrected estimates obtained from Equations (12), and the corresponding theoretical prices (in €) of one SAP stock option with 10 years to maturity on December 31, 1999, when the stock price was €161.67. Option prices are given for freeze-out periods of 2, 3, and 4 years.This exhibits shows estimated autocorrelations and cross-autocorrelations based on 250 daily observations from the period preceding December 31, 1999. Autocorrelations are provided for up to 10 lags and cross-autocorrelations for up to five lags. Negative lags for the cross-atutocorrelations refer to lagged returns of the GSTI Software Index and positive lags to lagged returns of SAP stocks. The horizontal lines are the boundaries of a 95% confidence interval. SUMMARY AND CONCLUSIONLo and Wang [1995] have shown that the predictability of an asset's return has an impact on derivative prices since, for a fixed variance of finite-holding period returns, predictability changes the instantaneous variance. We extend Lo and Wang's analysis by considering 46 DO LEAD-LAG EFFECTS AFFECT DERIVATIVE PRICING? FALL 2007 E X H I B I T 5 Parameter Estimates and Quanto Forward Price AdjustmentsThis exhibit shows parameter estimates resulting from estimator (3), the corrected estimates obtained from Equations (12), and the corresponding discount rates from Equation (21). The data consists of daily returns on the BOVESPA Index and the relative changes of the value of U.S. $1 in Brazilian real over the year 2006.This exhibit shows parameter estimates resulting from estimator (3), the corrected estimates obtained from Equations (12), and the present value of the yearly incentive fee charged by the DWS European Stocks Type-O Fund (in percent of the net asset value). The data consists of daily returns of the fund and the MSCI Europe index over the year 2006.