- The CDS-Bond Basis, Financial Management, forthcoming
The limit-of-arbitrage story for the difference between CDS and cash-bond implied credit spread.
- Common Risk Factors in the Cross-Section of Corporate Bond Returns, Journal of Financial Economics, 2019, 131, 619-642.
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.
- The Leverage Effect and the Basket-Index Put Spread, Journal of Financial Economics, 2019, 131, 186-205.
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!
- Measuring Liquidity Mismatch in the Banking Sector, Journal of Finance, 2018, 73(1), 51-93.
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.
- Have Financial Markets Become More Informative? Journal of Financial Economics, 2016, 122(3), 625-654.
The finance industry has grown, financial markets have become more liquid, information technology has been revolutionized. But have financial market prices become more informative?
- Anchoring Corporate Credit Spreads to Firm Fundamentals, Journal of Financial & Quantitative Analysis, 2016, 51(5), 1521-1543.
This paper examines the capability of firm fundamentals in explaining the cross-sectional variation of CDS spreads.
- On Bounding Credit Event Risk Premia, Review of Financial Studies, 2015, 28(9), 2608-2642.
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.
- Property Rights Gaps and CDS Spreads: When Is There a Strong Transfer Risk from the Sovereigns to the Corporates? Quarterly Journal of Finance, 2017, 7(4), 1750013.
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.
- State Space Models and MIDAS Regressions, Econometric Reviews, 2013, 32(7), 779-813.
We examine the relationship between MIDAS and Kalman filter state space models applied to mixed frequency data.
- Is the Credit Spread Puzzle a Myth? (with Robert Goldstein and Fan Yang), R&R Journal of Financial Economics
- Safe Asset Shortages: Evidence from the European Government Bond Lending Market, (with Reena Aggarwal, and Luc Laeven), R&R Journal of Financial and Quantitative Analysis
- Can Equity Market Efficiency Help Improve the Quality of Credit Ratings? Evidence from a Controlled Experiment (with Sterling Huang, Massimo Massa and Hong Zhang)
We study whether and how the efficiency in the equity market affects the credit market. We exploit a unique experiment (“Regulation SHO”) which, by exogenously reducing transaction costs for short-sellers, improves efficiency in the equity market through increasing the informativeness of the firm. We show that higher efficiency significantly improves the buy-side investor-paid ratings but have little impact on sell-side issuer-paid ratings, because the change of ratings comes not from a lower probability of distress per se, but from a reduction in the uncertainty about the riskiness of the firm and from an enhancement of governance quality. The effect is stronger for firms rated below investment grades, for firms with low analyst coverage, and for firms with low institutional ownership.
- What Bond Lending Reveals? The Role of Informed Demand in Predicting Credit Spread Changes, August 2018
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.
- Do Distributional Characteristics of Corporate Bonds Predict Their Future Returns? (with Turan Bali and Quan Wen)
- The Microstructure of Chinese Government Bond Market, (with Michael Fleming, and Casidhe Horan)
- `Going Global': Markups and Product Quality in the Chinese Art Market, (with Benjamin Mandel and Jia Guo)
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.
We revisit Feldhutter and Schaefer (FS, 2018) who report evidence of a ``credit spread puzzle'' for high-yield but not investment-grade bonds. We show their results are reversed when their model is calibrated using market values of debt rather than book values. More importantly, we demonstrate that calibrating structural models of default to credit spreads rather than to historical default rates provides the statistical power necessary to reject the FS assumption that asset value dynamics follows geometric Brownian motion. A large market price of risk on jumps is required to match historical default rates, thus reaffirming a ``credit spread puzzle'' for investment-grade but not high-yield bonds.Security Lending and Corporate Financing (with Massimo Massa and Hong Zhang)
- The New Bank Resolution Regimes and "Too Big To Fail", (with Christian Cabanilla, and Menno Middeldorp, both from the Federal Reserve Bank of New York), Liberty Street Economics, October 2012.
- The Effects of Entering and Exiting a Credit Default Swap Index (with Or Sharchar, Federal Reserve Bank of New York), Liberty Street Economics, 2015