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Report
Global variance term premia and intermediary risk appetite
Sellers of variance swaps earn time-varying risk premia for their exposure to realized variance, the level of variance swap rates, and the slope of the variance swap curve. To measure risk premia, we estimate a dynamic term structure model that decomposes variance swap rates into expected variances and term premia. Empirically, we document a strong global factor structure in variance term premia across the U.S., U.K., Europe, and Japan. We further show that variance term premia are negatively correlated with the risk appetite of hedge funds, broker-dealers, and mutual funds. Our results ...
Report
Equity Volatility Term Premia
This paper estimates the term-structure of volatility risk premia for the stock market. Realized variance term premia are increasing in systematic risk and predict variance swap returns. Implied volatility term premia are decreasing in risk initially, but then increase at a lag, predicting VIX futures returns. By modeling the logarithm of realized variance, the paper derives a closed-form relationship between the prices of variance swaps and VIX futures. The model provides accurate pricing and highlights periods of dislocation between the index options and VIX futures markets. Term premia ...
Discussion Paper
Tax Reform's Impact on Bank and Corporate Cyclicality
The Tax Cuts and Jobs Act (TCJA) is expected to increase after-tax profits for most companies, primarily by lowering the top corporate statutory tax rate from 35 percent to 21 percent. At the same time, the TCJA provides less favorable treatment of net operating losses and limits the deductibility of net interest expense. We explain how the latter set of changes may heighten bank and corporate borrower cyclicality by making bank capital and default risk for highly levered corporations more sensitive to economic downturns.
Discussion Paper
The 2022 Spike in Corporate Security Settlement Fails
Settlement fails in corporate securities increased sharply in 2022, reaching levels not seen since the 2007-09 financial crisis. As a fraction of trading volume, fails that involve primary dealers reached an all-time high in the week of March 23, 2022. In this post, we investigate the 2022 spike in settlement fails for corporate securities and discuss potential drivers for this increase, including trading volume, corporate issuance, fails in bond ETFs, and operational problems.
Discussion Paper
The Low Volatility Puzzle: Are Investors Complacent?
In recent months, some analysts and policymakers have raised concerns about the unusually low level of stock market volatility. For example, in the June Federal Open Market Committee (FOMC) minutes ?a few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability.? In this post, we review this concern and find the evidence on investor complacency is mixed. On one hand, we present a view suggesting that historical volatility may have been abnormally high, rather than current volatility being ...
Discussion Paper
The COVID-19 Pandemic and the Fed’s Response
The Federal Reserve has taken unprecedented actions to mitigate the effects of the COVID-19 pandemic on U.S. households and businesses. These measures include cutting the Fed’s policy rate to the zero lower bound, purchasing Treasury and mortgage-backed securities (MBS) to promote market functioning, and establishing several liquidity and credit facilities. In this post, we briefly review the developments motivating these actions, summarize what the Fed has done and why, and compare the Fed’s response with its response to the 2007-09 financial crisis.
Report
Bank-intermediated arbitrage
We argue that post-crisis banking regulations pass through from regulated institutions to unregulated arbitrageurs. We document that, once post-crisis regulations bind post 2014, hedge funds use a larger number of prime brokers and diversify away from GSIB-affiliated prime brokers, and that the match to such prime brokers is more fragile. Tighter regulatory constraints disincentivize regulated institutions not only to engage in arbitrage activity themselves but also to provide leverage to other arbitrageurs. Indeed, we show that the maximum leverage allowed and the implied return on basis ...
Discussion Paper
Regulatory Changes and the Cost of Capital for Banks
In response to the financial crisis nearly a decade ago, a number of regulations were passed to improve the safety and soundness of the financial system. In this post and our related staff report, we provide a new perspective on the effect of these regulations by estimating the cost of capital for banks over the past two decades. We find that, while banks? cost of capital soared during the financial crisis, after the passage of the Dodd-Frank Act (DFA), banks experienced a greater decrease in their cost of capital than nonbanks and nonbank financial intermediaries (NBFI).
Discussion Paper
The Primary and Secondary Market Corporate Credit Facilities
On April 9, the Federal Reserve announced that it would take additional actions to provide up to $2.3 trillion in loans to support the economy in response to the coronavirus pandemic. Among the initiatives are the Primary Market and Secondary Market Corporate Credit Facilities (PMCCF and SMCCF), whose intent is to provide support for large U.S. businesses that typically finance themselves by issuing debt in capital markets. Corporate bonds support the operations of companies with more than 17 million employees based in the United States and these bonds are key assets for retirees and pension ...
Discussion Paper
The Low Volatility Puzzle: Is This Time Different?
As stock market volatility hovers near all-time lows, some analysts are questioning whether investors are complacent, drawing an analogy to the lead-up to the financial crisis. But, is this time different? We follow up on our previous post by investigating the persistence of low volatility periods. Historically, realized stock market volatility is persistent and mean-reverting: low volatility today predicts slightly higher, but still low, volatility one month and one year from now. Moreover, as of mid-September, the market is pricing implied volatility of 19 percent in one to two years? time. ...