Master in Financial Engineering at EPFL:

Advanced Topics in Financial Econometrics

Prof. Loriano Mancini
Swiss Finance Institute at EPFL
Third semester

Content
The course presents some advanced topics in Financial Econometrics, such as semiparametric and
nonparametric option pricing; measuring liquidity in FX market using ultra high-frequency data; estimating integrated variance eciently with ultra high-frequency noise-contaminated data; inference
on stochastic volatility models; variance swaps.

Structure of the course

Recall principles of statistical inference, Maximum Likelihood, etc. Recall basic nance concepts, derivative instruments, BlackScholes implied volatility, etc.
Stochastic discount factor; risk neutral pricing; suggested books: Campbell, Lo, and MacKinlay
(1997) and Jondeau, Poon, and Rockinger (2006). GARCH option pricing; Risk neutralizing
GARCH dynamic, Duan (1995)
GARCH option pricing inverting characteristic function, Heston and Nandi (2000); semiparametric GARCH option pricing, Barone-Adesi, Engle, and Mancini (2008)
Nonparametric modeling; Kernel regression; local linear regression; optimal bandwidth; suggested book: Fan and Yao (2003). Nonparametric option pricing; Smoothing implied volatility;
At-Sahalia and Lo (1998)

E-mail: [email protected]

 Nonparametric option pricing under shape restrictions, At-Sahalia and Duarte (2003); Modelguided nonparametric option pricing, Fan and Mancini (2009)
Ultra high frequency data; discreteness of price changes; irregular temporal spacing; diurnal
patterns and temporal dependencies of volatilities, volumes, and durations, Engle and Russell
(2002); marked point process; hazard rate; Autoregressive Conditional Duration model, Engle
and Russell (1998); VAR models of marks in tick time
Construction of regularly spaced time grid; correlation; Epps eect, Epps (1979); Integrated
variance; Market microstructure noise
Two-scale realized volatility, Zhang, Mykland, and At-Sahalia (2005), At-Sahalia and Mancini
(2008)
Liquidity in equity market, Pastor and Stambaugh (2003), Korajczyk and Sadka (2008)
Liquidity in FX market, Evans and Lyons (2002), Lustig, Roussanov, and Verdelhan (2008),
Mancini, Ranaldo, and Wrampelmeyer (2013)
Variance swap rates; Stochastic volatility, Heston (1993); Stochastic volatility jump diusion
model, Pan (2002)
Variance risk premia, Carr and Wu (2009); Inference on stochastic volatility models, AtSahalia, Karaman, and Mancini (2012), Filipovic, Gourier, and Mancini (2012)
If time allows: Value at Risk prediction; Bounded Inuence Function estimation of stochastic
volatility models and tail return distributions; Extreme Value Theory, suggested book: Embrechts, Kl
uppelberg, and Mikosch (1997)
If time allows: Filtering historical simulation; Robust Value at Risk prediction, Mancini and
Trojani (2011)

Assignment
There will be one assignment which will require to t a GARCH model to S&P 500 index returns
using Pseudo Maximum Likelihood; calculate European option prices via Monte Carlo simulation;
recover BlackScholes implied volatility smile; t nonparametrically the implied volatility smile.

Grade
40% homework, 60% nal oral exam on the material and research papers covered in class.

Prerequisites
Prior knowledge of basic concepts in Financial Economics, option pricing, Econometrics, and Time
series analysis is required. Familiarity with software, such as Matlab, for simulations and empirical
analysis is required as well.

References
At-Sahalia, Y., and J. Duarte, 2003, Nonparametric option pricing under shape restrictions,
Journal of Econometrics, 116, 947.
At-Sahalia, Y., M. Karaman, and L. Mancini, 2012, The term structure of variance swaps, risk
premia and the expectation hypothesis, working paper, EPFL and Princeton University.
At-Sahalia, Y., and A. W. Lo, 1998, Nonparametric estimation of state-price densities implicit in
nancial assets prices, Journal of Finance, 53, 499548.
At-Sahalia, Y., and L. Mancini, 2008, Out of sample forecasts of quadratic variation, Journal of
Econometrics, 147, 1733.
Barone-Adesi, G., R. F. Engle, and L. Mancini, 2008, A GARCH option pricing model with ltered
historical simulation, Review of Financial Studies, 21, 12231258.
Campbell, J. Y., A. W. Lo, and C. MacKinlay, 1997, The econometrics of financial markets. Princeton University Press, Princeton, NY.
Carr, P., and L. Wu, 2009, Variance risk premia, Review of Financial Studies, 22, 13111341.
Duan, J.-C., 1995, The GARCH Option Pricing Model, Mathematical Finance, 5, 1332.
Embrechts, P., C. Kl
uppelberg, and T. Mikosch, 1997, Modelling extremal events for insurance and
finance. Springer, Berlin.
Engle, R. F., and J. Russell, 1998, Autoregressive conditional duration: A new model for irregularly
spaced transaction data, Econometrica, 66, 11271162.

Engle, R. F., and J. R. Russell, 2002, Analysis of high frequency nancial data, in Handbook of
Financial Econometrics, ed. by Y. At-Sahalia, and L. P. Hansen. North Holland, Amsterdam, The
Netherlands.
Epps, T. W., 1979, Comovements in stock prices in the very short run, Journal of the American
Statistical Association, 74, 291298.
Evans, M. D. D., and R. Lyons, 2002, Order ow and exchange rate dynamics, Journal of Political
Economy, 110, 170180.
Fan, J., and L. Mancini, 2009, Option pricing with model-guided nonparametric methods, Journal
of the American Statistical Association, 104, 13511372.
Fan, J., and Q. Yao, 2003, Nonlinear time series: Nonparametric and parametric methods. SpringerVerlag, New York.
Filipovic, D., E. Gourier, and L. Mancini, 2012, Quadratic variance swap models, working paper,
EPFL.
Heston, S., 1993, A closed-form solution for options with stochastic volatility, with applications to
bond and currency options, Review of Financial Studies, 6, 327343.
Heston, S., and S. Nandi, 2000, A closed-form GARCH option valuation model, Review of Financial
Studies, 13, 585625.
Jondeau, E., S.-H. Poon, and M. Rockinger, 2006, Financial modeling under non-gaussian distributions. Springer Finance.
Korajczyk, R. A., and R. Sadka, 2008, Pricing the commonality accross alternative measures of
liquidity, Journal of Financial Economics, 87, 4572.
Lustig, H. N., N. L. Roussanov, and A. Verdelhan, 2008, Common risk factors in currency markets,
working paper, NBER.
Mancini, L., A. Ranaldo, and J. Wrampelmeyer, 2013, Liquidity in the foreign exchange market:
Measurement, commonality, and risk premiums, Journal of Finance, 68, 18051841.
Mancini, L., and F. Trojani, 2011, Robust Value at Risk prediction, Journal of Financial Econometrics.

Pan, J., 2002, The jump-risk premia implicit in options: Evidence from an integrated time-series
study, Journal of Financial Economics, 63, 350.
Pastor, L., and R. F. Stambaugh, 2003, Liquidity risk and expected stock returns, Journal of
Political Economy, 111, 642685.
Zhang, L., P. A. Mykland, and Y. At-Sahalia, 2005, A tale of two time scales: Determining integrated volatility with noisy high-frequency data, Journal of the American Statistical Association,
100, 13941411.