Essays in financial economics (Argentina, Brazil, Mexico)

Essay 1. In this essay, we investigate the theoretical and empirical differences between the convexity adjustment method and the LIBOR market model in pricing two-period constant maturity swap (CMS). Using daily data, we obtain the differences (spreads) between the two-period CMS rates calculated from the convexity adjustment and those from the LIBOR market model. The convexity adjustment method yields higher CMS rates than the LIBOR market model does. The spreads are correlated with the cap volatilities and the yield curves.; Essay 2. Developing countries need flexibility in borrowing from the international capital markets; and are susceptible to liquidity risk when foreign capital flow reverses. Contingent credit lines (CCL) contract could be used to inject liquidity and back the exchange reserves held in the central banks. This essay presents a pricing method for the CCL contract signed by sovereign borrowers and banks. CCL can be modelled as a reverse knock-out option whose underlying instrument is credit spread. We apply the LIBOR market model under survival measure to price CCL for three countries: Argentina; Brazil and Mexico.; Essay 3. This essay introduces a conditional volatility estimator based on the skewed fat-tailed generalized error distribution (SLED) within a discrete-time LARCH model. The information content of the SLED-LARCH volatility estiorators is compared with those of the implied volatility index (VIX) and the fitted realized volatility models for 1-day-ahead and 20-day-ahead forecasts of the S&P 100 index volatility. The in-sample and out-of-sample performance results based on the R2 and the mean absolute percentage errors imply superior performance of the SLED-TGARCH and the VIX in capturing time-series variation in realized volatility. The results also suggest that nearly all information is provided by the SLED-TGARCH, the VIX, and the sum of the squared five-minute returns. There is little incremental information in the traditional volatility estimator based on the absolute demeaned daily index returns.