The Fédération Bancaire Française (FBF) "Structured Products and Derivatives" Research Chair is under the scientific responsibility of Lionel Martellini, Scientific Director of EDHEC-Risk Institute.

The objective of the FBF Structured Products and Derivatives Research Chair is to examine structured products with regard to clients' specific requirements.

The research chair will focus on three research projects:

• The optimal design of structured products.

• Structured products and derivatives in active/passive management.

• Structured products and derivatives on underlying instruments that are illiquid or lack liquidity.

The FBF (French Banking Federation) will support the research chair over a five year period. This research chair, which was awarded to EDHEC-Risk Institute, was one of five high-level research chairs in the field of corporate and investment banking offered by the FBF to increase the competitiveness of the French financial market.

Research Output

Idiosyncratic Risk and the Cross-Section of Stock Returns
February 2011
Rene Garcia, Daniel Mantilla-Garcia, Lionel Martellini
Idiosyncratic volatility has received considerable attention is the recent financial literature. Whether average idiosyncratic volatility has recently risen, whether it is a good predictor for aggregate market returns and whether it has a positive relationship with expected returns in the cross-section are still matters of active debate. We revisit these questions from a novel perspective, by taking the cross-sectional variance of stock returns as a measure of average idiosyncratic variance. Two key advantages of this measure are its model-free nature and its observability at any frequency, which allows us to present new results on the properties of daily idiosyncratic volatility series. Through central limit arguments, we formally show that the cross-sectional dispersion of stock returns can be regarded as a consistent and asymptotically efficient estimator for idiosyncratic volatility. We empirically confirm that the cross-sectional measure provides a very good proxy for average idiosyncratic risk as implied by standard asset pricing models and that it predicts well aggregate returns, especially at the daily frequency. The predictability power of idiosyncratic risk is further increased when adding a measure of cross-sectional skewness to the cross-sectional variance factor. We finally provide evidence that idiosyncratic risk is a positively rewarded risk factor.

Option Pricing and Hedging in the Presence of Basis Risk
February 2011
Lionel Martellini, Vincent Milhau
This paper addresses the problem of option hedging and pricing when a futures contract, written either on the underlying asset or on some imperfectly correlated substitute for the underlying asset, is used in the dynamic replication of the option payoff. In the presence of unspanned basis risk modeled as a Brownian bridge process, which explicitly accounts for the convergence of the basis to zero as the futures contract approaches maturity, we are able to obtain an analytical expression for the optimal hedging strategy and corresponding option price. Empirical analysis suggests that the hedging demand against basis risk is an important ingredient of the hedging strategy. For reasonable parameter values, we also find the replication error implied by the optimal strategy to be substantially lower than that implied by heuristic strategies routinely used in practice.

Option Pricing and Hedging in the Presence of Cross-Hedge Risk
June 2010
Lionel Martellini, Vincent Milhau
This paper addresses the question of option pricing and hedging when the underlying asset is not available for dynamic trading, and some other asset is used as a substitute. It first provides an overview of the various hedging methodologies that can be used in this incomplete market setting, distinguishing between self-financing and non-self-financing strategies. Focussing on a local risk-minimization criterion, it presents an analytical expression for the optimal hedging strategy and the corresponding option price. It also provides a quantitative measure of the residual risk over the life of the option. The paper finds that the use of the optimal strategy induces a much smaller replication error compared to the replication error induced by a naive Black-Scholes strategy, especially for low levels of the correlation between the underlying asset and the substitute. In the absence of transaction costs, it also finds that cross hedge risk is more substantial than the risk induced by discrete trading for reasonable parameter values. While this result implies that trading in the substitute can only be rationalised for exceedingly high correlations, the presence of (higher levels of) transaction costs is likely, however, to make trading in the actual underlying asset a prohibitively costly alternative. [Press release announcing the publication of the research: 17/02/2011]

The Benefits of Structured Products in Asset-Liability Management
December 2008
Lionel Martellini, Vincent Milhau
This paper introduces a continuous-time dynamic asset allocation model for an investor facing liability constraints in the presence of inflation and interest rate risks. When funding ratio constraints are explicitly accounted for, the optimal policies, for which we obtain analytical expressions, are shown to extend standard Option-Based Portfolio Insurance (OBPI) strategies to a relative risk context, with the liability-hedging portfolio replacing the risk-free asset. We also show that the introduction of maximum funding ratio targets would allow pension funds to decrease the cost of downside liability risk protection while giving up part of the upside potential beyond levels where marginal utility of wealth (relative to liabilities) is low or almost zero.

Related Events

Events in French

 Présentation : Une meilleure mesure de la volatilité pour une meilleure gestion des risques
12 décembre 2011 - Paris

Les informations sur les fluctuations de volatilité étant d’une importance primordiale pour les acteurs du marché, plusieurs initiatives ont récemment été lancées afin de mettre des mesures de volatilité à la disposition des investisseurs dans la forme d’indices de volatilité.

Dans le même temps, on constate que dans le cadre d’une allocation d’actifs stratégique, la prévisibilité des rendements peut être perturbée par des changements importants dans la volatilité des cours d’actifs. Un bon modèle statistique pour capter ces perturbations est le modèle à changement de régime de Markov.

Dans le cadre de la chaire « Produits Structurés et Produits Dérivés » de l’EDHEC-Risk Institute, soutenue par la Fédération Bancaire Française, les professeurs Lionel Martellini et René Garcia de l’EDHEC présenteront les résultats de leurs derniers travaux dans ces deux domaines et démontreront la pertinence de ces recherches pour les professionnels de la finance.

About the Fédération Bancaire Française

The French Banking Federation (FBF) promotes the banking and financial services industries in the French, European and international markets, and sets out the industry's positions and proposals to officials and regulatory authorities in the fields of business and finance. The FBF also issues professional recommendations and agreements, and makes its experience available to its members. Its mission also includes keeping members among French banks informed of anything that may concern their activities.

To fulfil its mandate, the FBF is structured around three departments:

• Banking and Financial Activities and Research

  This department offers a full range of banking expertise, and oversees the FBF's commissions and committees in areas including retail banking and direct banking, investment banking and capital markets, risk control and capital adequacy requirements, payment systems and instruments, and legal and tax issues. It also negotiates and works with various French and European government and regulatory authorities.

• Information and External Relations

  The role of this department is to anticipate changes in the political, economic and social environment, promote the role of the banking sector in society and keep the general public informed. It is responsible for public affairs, including relations with government officials, the media, consumers, young people and teachers. It makes sure that banks are kept informed, and organises the activity of the FBF's regional committees.

• European and International Affairs

  This department, based in Brussels and in Paris, handles relations with EU institutions and the various bodies representing the banking and financial services industries in Europe. It monitors international issues and relations with global banking associations, and deals with issues that specifically concern foreign banks operating in France.

Website: www.fbf.fr