Search Results
Working Paper
The Two-Pillar Policy for the RMB
We document stylized facts about China's recent exchange rate policy for its currency, the renminbi (RMB). Our empirical findings suggest that a "two-pillar policy" is in place, aiming to balance RMB index stability and exchange rate flexibility. We then develop a tractable no-arbitrage model of the RMB under the two-pillar policy. Using derivatives data on the RMB and the U.S. dollar index, we estimate the model to assess financial markets' views about the fundamental exchange rate and sustainability of the policy. Our model is able to predict the modification of the two-pillar policy in May ...
Working Paper
Hedging and Pricing in Imperfect Markets under Non-Convexity
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.
Working Paper
Ambiguity Aversion and Variance Premium
This paper offers an ambiguity-based interpretation of variance premium?the difference between risk-neutral and objective expectations of market return variance?as a compounding effect of both belief distortion and variance differential regarding the uncertain economic regimes. Our approach endogenously generates variance premium without imposing exogenous stochastic volatility or jumps in consumption process. Such a framework can reasonably match the mean variance premium as well as the mean equity premium, equity volatility, and the mean risk-free rate in the data. We find that about 96 ...
Working Paper
Monetary policy surprises, positions of traders, and changes in commodity futures prices
Using futures data for the period 1990?2008, this paper finds evidence that expansionary monetary policy surprises tend to increase crude and heating oil prices, and contractionary monetary policy shocks increase gold and platinum prices. Our analysis uncovers substantial heterogeneity in the magnitude of this response to positive and negative surprises across different commodities and commodity groups. The results also suggest that the positions of futures traders for the metals and energy commodities strongly respond to monetary policy shocks. The adjustment of the net long positions of ...
Working Paper
Asset Co-movements: Features and Challenges
This paper documents and characterizes the time-varying structure of U.S. and international asset co-movements. Although some of the time variation could be genuine, the sampling uncertainty and time series properties of the series can distort significantly the underlying signal dynamics. We discuss examples that illustrate the pitfalls from drawing conclusions from local trends of asset prices. On a more constructive side, we find that the U.S. main asset classes and major international stock indices share a factor that is closely related to the business cycle. At even lower frequency, the ...
Working Paper
Ambiguity, Long-Run Risks, and Asset Prices
I generalize the long-run risks (LRR) model of Bansal and Yaron (2004) by incorporatingrecursive smooth ambiguity aversion preferences from Klibanoff et al. (2005, 2009) and time-varyingambiguity. Relative to the Bansal-Yaron model, the generalized LRR model is as tractable but moreflexible due to its separation of ambiguity aversion from both risk aversion and the intertemporalelasticity of substitution. This three-way separation allows the model to further account for thevariance premium puzzle besides the puzzles of the equity premium, the risk-free rate, and the returnpredictability. ...
Working Paper
Estimating Loss Given Default from CDS under Weak Identification
This paper combines a term structure model of credit default swaps (CDS) with weak-identification robust methods to jointly estimate the probability of default and the loss given default of the underlying firm. The model is not globally identified because it forgoes parametric time series restrictions that have aided identification in previous studies, but that are also difficult to verify in the data. The empirical results show that informative (small) confidence sets for loss given default are estimated for half of the firm-months in the sample, and most of these are much lower than and do ...
Working Paper
Are Equity Option Returns Abnormal? IPCA Says No
We show that much of the profitability in equity option return strategies, which try to capture option mispricing by taking exposure to underlying volatility, can be explained by an IPCA model. The alpha reduction, relative to competing static factor models, is between 50% and 75% depending on the computing model and the type of option position.
Working Paper
Is Implied Correlation Worth Calculating? Evidence from Foreign Exchange Options and Historical Data
Implied volatilities, as derived from option prices, have been shown to be useful in forecasting the subsequently observed volatility of the underlying financial variables. In this paper, we address the question of whether implied correlations, derived from options on the exchange rates in a currency trio, are useful in forecasting the observed correlations. We compare the forecast performance of the implied correlations from two currency trios with markedly different characteristics against correlation forecasts based on historical, time-series data. For the correlations in the USD/DEM/JPY ...
Working Paper
Partisan Impacts on the Economy: Evidence from Prediction Markets and Close Elections
Political economists interested in discerning the effects of election outcomes on the economy have been hampered by the problem that economic outcomes also influence elections. We sidestep these problems by analyzing movements in economic indicators caused by clearly exogenous changes in expectations about the likely winner during election day. Analyzing high frequency financial fluctuations on November 2 and 3 in 2004, we find that markets anticipated higher equity prices, interest rates, and oil prices and a stronger dollar under a Bush presidency than under Kerry. A similar ...