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Working Paper
Firm-Specific Risk-Neutral Distributions : The Role of CDS Spreads
Jahan-Parvar, Mohammad; Schindler, John W.; Aramonte, Sirio; Rosen, Samuel (2017-08-31)
We propose a method to extract individual firms' risk-neutral return distributions by combining options and credit default swaps (CDS). Options provide information about the central part of the distribution, and CDS anchor the left tail. Jointly, options and CDS span the intermediate part of the distribution, which is driven by moderate-sized jump risk. We study the returns on a trading strategy that buys (sells) stocks exposed to positive (negative) moderate-sized jump risk unspanned by options or CDS individually. Controlling for many known factors, this strategy earns a 0.5% premium per ...
International Finance Discussion Papers , Paper 1212

Report
Understanding mortgage spreads
Boyarchenko, Nina; Lucca, David O.; Fuster, Andreas (2014-05-01)
Most mortgages in the U.S. are securitized in agency mortgage-backed securities (MBS). Yield spreads on these securities are thus a key determinant of homeowners? funding costs. We study variation in MBS spreads over time and across securities, and document a cross-sectional smile pattern in MBS spreads with respect to the securities? coupon rates. We propose non-interest-rate prepayment risk as a candidate driver of MBS spread variation and present a new pricing model that uses ?stripped? MBS prices to identify the contribution of this prepayment risk to the spread. The pricing model finds ...
Staff Reports , Paper 674

Report
Simple and reliable way to compute option-based risk-neutral distributions
Malz, Allan M. (2014-06-01)
This paper describes a method for computing risk-neutral density functions based on the option-implied volatility smile. Its aim is to reduce complexity and provide cookbook-style guidance through the estimation process. The technique is robust and avoids violations of option no-arbitrage restrictions that can lead to negative probabilities and other implausible results. I give examples for equities, foreign exchange, and long-term interest rates.
Staff Reports , Paper 677

Journal Article
The Financial Stability Implications of Digital Assets
Azar, Pablo D.; Baughman, Garth; Carapella, Francesca; Gerszten, Jacob; Lubis, Arazi; Perez-Sangimino, JP; Rappoport, David E.; Scotti, Chiara; Swem, Nathan; Vardoulakis, Alexandros; Werman, Aurite (2024-11-01)
Financial activity associated with digital assets has grown rapidly, raising concerns about financial stability risks. This article presents an overview of these risks, adapting the Federal Reserve’s framework for monitoring financial stability in the traditional financial system. The overview reveals that the observed fragility of digital assets is associated with several financial vulnerabilities: valuation pressures of crypto assets, funding risk in most crypto sectors, the widespread use of leverage, and a highly interconnected crypto ecosystem. However, to date, these vulnerabilities ...
Economic Policy Review , Volume 30 , Issue 2 , Pages 1-48

Working Paper
Is There an On-the-Run Premium in TIPS?
Christensen, Jens H. E.; Lopez, Jose A.; Shultz, Patrick (2017-05-17)
In the U.S. Treasury market, the most recently issued, or so-called ?on-the-run,? security typically trades at a price above those of more seasoned but otherwise comparable securities. This difference is known as the on-the-run premium. In this paper, yield spreads between pairs of Treasury Inflation-Protected Securities (TIPS) with identical maturities but of separate vintages are analyzed. Adjusting for differences in coupon rates and values of embedded deflation options, the results show a small, positive premium on recently issued TIPS - averaging between one and four basis points - that ...
Working Paper Series , Paper 2017-10

Working Paper
Variance Disparity and Market Frictions
Park, Yang-Ho (2019-08)
This paper introduces a new model-free approach to measuring the expectation of market variance using VIX derivatives. This approach shows that VIX derivatives carry different information about future variance than S&P 500 (SPX) options, especially during the 2008 financial crisis. I find that the segmentation is associated with frictions such as funding illiquidity, market illiquidity, and asymmetric information. When they are segmented, VIX derivatives contribute more to the variance discovery process than SPX options. These findings imply that VIX derivatives would offer a better estimate ...
Finance and Economics Discussion Series , Paper 2019-059

Working Paper
Quantities and Covered-Interest Parity
Moskowitz, Tobias J.; Ross, Chase P.; Ross, Sharon Y.; Vasudevan, Kaushik (2024-08-02)
Studies of intermediated arbitrage argue that bank balance sheets are an important consideration, yet little evidence exists on banks’ positioning in this context. Using confidential supervisory data (covering $25 trillion in daily notional exposures) we examine banks’ positions in connection with covered-interest parity (CIP) deviations. Exploiting cross-sectional variation in CIP deviations that have largely challenged existing theories, we document three novel forces that drive bases: 1) foreign safe asset scarcity, 2) market power and segmentation of banks specializing in different ...
Finance and Economics Discussion Series , Paper 2024-061

Working Paper
Hedging and Pricing in Imperfect Markets under Non-Convexity
Assa, Hirbod; Gospodinov, Nikolay (2014-08-01)
This paper proposes a robust approach to hedging and pricing in the presence of market imperfections such as market incompleteness and frictions. The generality of this framework allows us to conduct an in-depth theoretical analysis of hedging strategies for a wide family of risk measures and pricing rules, which are possibly non-convex. The practical implications of our proposed theoretical approach are illustrated with an application on hedging economic risk.
FRB Atlanta Working Paper , Paper 2014-13

Working Paper
The Financial Stability Implications of Digital Assets
Scotti, Chiara; Carapella, Francesca; Rappoport, David E.; Baughman, Garth; Swem, Nathan; Vardoulakis, Alexandros (2022-08)
The value of assets in the digital ecosystem has grown rapidly, amid periods of high volatility. Does the digital financial system create new potential challenges to financial stability? This paper explores this question using the Federal Reserve’s framework for analyzing vulnerabilities in the traditional financial system. The digital asset ecosystem has recently proven itself highly fragile. However adverse digital asset markets shocks have had limited spillovers to the traditional financial system. Currently, the digital asset ecosystem does not provide significant financial services ...
Finance and Economics Discussion Series , Paper 2022-058

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