Fair Value Model for Mutual Fund Securities
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Solution Overview
Problem
Mutual funds with foreign or thinly traded assets face challenges in accurately valuing securities due to time zone differences, leading to potential arbitrage opportunities that disadvantage long-term investors, as NAV calculations often rely on stale prices, allowing short-term traders to profit at their expense.
Innovation Solution
A system and method for computing fair value prices of financial securities by adjusting for time-zone differences, using time-series regression to calculate return factor coefficients and predict overnight returns, which are then used to determine fair value prices, thereby reducing arbitrage opportunities.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Productivity
If NAV is calculated based on closing prices from foreign markets, then the calculation is simple and fast, but the prices become stale and allow short-term traders to profit from information asymmetry
Solution Approach 1:
The system performs preliminary actions by calculating fair value adjustments before the foreign market closes. It uses time-series regression models to predict overnight returns based on domestic market return factors, establishing adjusted prices in advance that reflect expected price movements, thereby eliminating the stale price problem while maintaining calculation efficiency.
Solution Approach 2:
The patent introduces domestic market return factors as intermediaries to bridge the time zone gap. These return factors serve as mediators that capture market movements during the foreign market closure period, allowing the system to infer foreign market price changes without directly observing them, thus maintaining both speed and accuracy.
2Reliability
If short-term trading fees are imposed to limit arbitrage opportunities, then some protection is provided, but the fees are not large enough or universal enough to fully protect long-term investors
Solution Approach 1:
The patent converts the harmful effect of time zone differences (which create arbitrage opportunities) into a benefit by using the same time zone differential as the basis for calculating fair value adjustments. The system leverages domestic market movements during foreign closure periods to predict and adjust for foreign market changes, turning the information asymmetry problem into a solution mechanism.
3Ease of operation
If Internet trading is enabled for international funds, then trading accessibility improves, but arbitrage opportunities increase due to faster order processing
Solution Approach 1:
The system performs preliminary fair value calculations before trading occurs, establishing adjusted prices that anticipate market movements. This preliminary action removes the information asymmetry that enables arbitrage, allowing Internet trading to proceed freely without creating exploitation opportunities for short-term traders.
Data Source
AI summary
A method for determining fair value prices of financial securities of international markets includes the steps of selecting a universe of securities of a particular international market; computing overnight returns of each security in the selected universe over a predetermined past period of time; selecting at least one return factor of a domestic financial market from a plurality of return factors; computing, for each selected return factor, the return factor's daily return over said predetermined past period of time; calculating, for each selected return factor, a return factor coefficient for each security in the selected universe by performing a time series regression to obtain the contribution of each return factor's return to the security's overnight return; and storing each calculated return factor coefficient in a data file; wherein the stored return factor coefficients can be used in conjunction with current return factor daily return values to predict current overnight returns for all securities in the selected universe of securities, which predicted current overnight returns can be used in conjunction with closing prices on said particular international market of each security of said selected universe to determine a fair value price of each security of the selected universe. A system and computer program product for implementing the method also are provided.