Publications

​Co-authors: Turan Bali and Quan Wen
We investigate the cross-sectional determinants of corporate bonds and find that downside risk is the strongest predictor of future bond returns. We also introduce common risk factors based on the prevalent risk characteristics of corporate bonds -- downside risk, credit risk, and liquidity risk -- and find that these novel bond market factors have economically and statistically significant risk premia, which cannot be explained by the long-established stock and bond market factors. We further show that these newly proposed risk factors outperform all other models considered in the literature in explaining the returns of the industry-sorted and size/maturity-sorted portfolios of corporate bonds.

Co-authors: Robert Goldstein and Fan Yang
A model specifies asset dynamics instead of equity dynamics alone can explain the large spread in prices between put options written on individual banks and options written on the bank index during the financial crisis, even without the government bail-out story. It's important to look at equity and debt together!

​Co-authors: Arvind Krishnamurthy and Charles-Henri Weymuller
We propose a novel measure, "Liquidity Mismatch Index (LMI)," to gauge the mismatch between the market liquidity of assets and the funding liquidity of liabilities for the banking sector. LMI can be used for macro-prudential liquidity stress test, and for predicting cross-sectional bank risk. The outperformance of LMI than Basel III's LCR, NSFR results from the time-varying liquidity sensitivity weights which are driven by market prices.
​ ​​Co-authors: Thomas Philippon and Alexi Savov.      Media: -Bloomberg, New York Times 
​The finance industry has grown, financial markets have become more liquid, information technology has been revolutionized. But have financial market prices become more informative? 

Co-author: Liuren Wu
This paper examines the capability of firm fundamentals in explaining the cross-sectional variation of CDS spreads. 

Co-authors: Pierre Collin-Dufresne, Robert Goldstein, and Jean Helwege 
Reduced form models of default that attribute a large fraction of credit spreads as compensation for credit event risk typically preclude the most plausible economic justification for such risk to be priced, namely, a ``contagious" response of the market portfolio during the credit event. 
​ ​Co-author: Shang-Jin Wei
Strong property rights institutions tend to weaken the sovereign transfer risk, whereas contracting institutions (protection of creditor rights or minority shareholder rights) do not matter.

Co-authors: Eric Ghysels and Jonathan Wright
​We examine the relationship between MIDAS and Kalman filter state space models applied to mixed frequency data. 

Working Papers

​​ We investigate both the time-series and cross-sectional variation in the CDS-bond basis, which measures the difference between the CDS spread and cash-bond implied credit spread, for a large sample of individual firms during the financial crisis. We test several possible explanations for the violation of the arbitrage relation between cash bond and CDS contract that would, in normal conditions, drive the basis to zero. Our findings do not uncover a clear single explanatory factor for the anomaly. Rather they point towards several drivers related to funding risk, counterparty risk and collateral quality that force the individual bond basis into negative territory at different phases of the crisis.

Chengtou bond is the soli asset with market prices that can capture the funding cost of Chinese local government debt. In contrast to the U.S. municipal bonds, Chengtou bonds are issued by private corporations but implicitly guaranteed by the local hence central governments, which are reflected by novel risk characteristics---real estate GDP and political risk. One standard deviation increase in local real estate GDP (political risk) corresponds to 10 (9) basis points decrease (increase) in bond yields, respectively. However, conditional on political risk, real estate GDP actually increases bond yields, suggesting that only local governments with low political risk can enjoy the low funding costs driven by high real estate growth. ​

The European government bond lending market, as a core short-term funding market, not only facilitates short-selling, but also plays a unique role in allowing borrowers access to safe assets in market stress, especially with relatively low-quality noncash collateral. This feature is important since it increases the velocity of safe assets, and hence alleviates the pressure of the safe assets shortage. We provide strong evidence that safe assets have higher demand, higher borrowing cost, and higher usage of noncash collateral during the stressed market conditions. We also show that policy interventions by central banks impact the government bond lending market, and help reduce safe asset shortages by increasing confidence in non-safe bonds and by returning sought-after safe assets to the market.
​ This paper studies information flows within mutual fund families by analyzing investment decisions of equity funds and corporate bond funds on the same firm's assets. We find that funds linked within a mutual fund family (sister funds) exhibit a significant co-movement in holdings of commonly-held firms' equities and bonds (cross-holdings). In contrast, we do not find such a pattern from randomly matched equity and bond funds belonging to different fund families (stand-alone funds) but holding the same firm's assets, suggesting that the holding co-movement is driven by information sharing among sister funds. We show that sister funds make more profit-enhancing investment decisions on their cross holdings relative to stand-alone funds. Our findings suggest that enhancing collaboration between equity funds and bond funds help improve the performance of fund families.​

The security lending market allows institutional investors, such as insurance companies, to lend out their holding assets in exchange for cash collaterals, an important but understudied source of funding for corporate bond lenders. Since these lenders are also the primary investors of corporate bonds, we hypothesize that their demand on certain types of bonds originated from the security lending market can influence corporate financing policies, a demand-driven perspective. Using corporate bond lending data over a sample period from 2005 to 2014, we show that the lending market demand on long-term bonds stimulates firms to issue more such bonds and helps boost bond price. Analysis exploiting a quasi-experiment introduced by the 2010 regulation of National Association of Insurance Commissioners (NAIC) supports a causal interpretation. Our results shed new insight on corporate financing policies and bond pricing.

  • What Bond Lending Reveals? The Role of Informed Demand in Predicting Credit Spread Changes, August 2018
Corporate bond lending market is 2~3 times larger than corporate bond trading market, which makes it contain unique information on top of bond trading market. Using the lending information on both prices and quantities, we construct a proxy of informed demand and study its role in predicting the credit spread changes. We find that informed demand exhibits highly significant predictive power on future credit spread changes, even controlling for credit risk, liquidity risk, and other long-established risk factors in Collin-Dufresne et al. (2001) and Zhang, Zhou, and Zhu (2009). We also nd that lending-
based informed demand only have predictive power in corporate bonds, but not in its derivative contract CDS. Therefore, the informed demand help explain the CDS-Bond basis, especially in normal times when limits-to-arbitrage constraints unbind.

Structural models of default allow the location of the default boundary to be identified from either default rates or credit spreads. Default rates are latent variables measured with significant noise, and correcting even small calibration errors can reverse conclusions drawn from such models. In contrast, credit spreads are observable, thus providing much more statistical power to test underlying model assumptions.  Short maturity credit spreads provide overwhelming evidence that firm dynamics include jumps. A large market price of risk on jumps is required to match historical default rates, thus reaffirming a ``credit spread puzzle'' for investment-grade bonds, but not for high-yield bonds.

We find a significantly positive (negative) relation between volatility (skewness) and the cross-section of corporate bond returns, whereas kurtosis does not make a robust incremental contribution to the predictability of future bond returns. The risk-adjusted return spreads in volatility (skewness) sorted portfolios represent compensation for differences in the level of idiosyncratic volatility (idiosyncratic skewness) and differential exposure to the common idiosyncratic volatility factor in the bond market. We also show that the new risk factors based on the distributional moments of bond returns represent an important source of common return variation missing from the long-established stock and bond market factors.​

Although China now has one of the largest government bond markets in the world, the market has received relatively little attention and analysis. We describe the history and structure of the market and assess its functioning. We find that trading in individual bonds was historically sparse but has increased markedly in recent years. We find also that certain announcements of macroeconomic news, such as China’s producer price index (PPI) and manufacturing purchasing managers’ index (PMI), have significant effects on yields, even when such yields are measured at a daily level. Despite the increased activity in the market, we are able to reject the null hypothesis of market efficiency under two different tests for four of the most actively traded bonds.

          Media: -Asia Week Guide article, The Art Newspaper, 
We analyze two reasons for export prices to be different across markets, namely quality differentiation and variable markups, and attempt to parse their relative importance and some of their underlying drivers. To overcome the substantial measurement issues in this task, we consider a particular industry as a special case: Chinese fine art. The simplicity of the supply-side of art vis-a-vis marginal cost and the wealth of data on its quality characteristics makes it possible to separately identify the markup and quality components of international relative prices for Chinese artworks. Through this lens, we trace the process of internationalization of Chinese art since the year 2000 and uncover a rich set of facts. We find strong support for quality sorting into international markets at both the level of artist and artwork, as well as substantial markup differences across destinations. Using a structural model of endogenous quality choice by Feenstra and Romalis (2012), we argue that much of the international quality premium is driven by specific distribution costs (whether physical or informational) rather than destination-specific preferences for quality.

Policy Report