“Can Cash Flow Expectations Explain Momentum and Reversal?” Job Market Paper
This paper uses the predicted patterns of cash flow expectations to differentiate among the three most prominent behavioral theories of stock return momentum and reversal. Using analyst earnings forecasts as a proxy for cash flow expectations, I trace the dynamics of the expectation errors for winner and loser stocks in a 24-month holding period, during which returns are characterized by a momentum phase followed by a reversal phase. The large positive cross-sectional difference in expectation errors between winner and loser stocks gradually shrinks to zero over the holding period. This pattern is most consistent with the underreaction hypothesis in Hong and Stein (1999), in which cash flow expectation errors can only explain momentum, and price extrapolation is needed to explain reversal.
“Volatility Components: The Term Structure Dynamics of VIX Futures,” with Yingzi Zhu, Journal of Futures Markets 30, no. 3 (2010): 230–256. http://onlinelibrary.wiley.com/doi/10.1002/fut.20415/abstract
In this paper we empirically study the variance term structure using VIX futures market. We first derive a new pricing framework for VIX futures that is convenient to study variance term structure dynamics. We construct five models and use Kalman filter and Maximum Likelihood method for model estimations and comparisons. We provide evidence that a third factor is statistically significant for variance term structure dynamics. We find that our parameter estimates are robust and helpful to shed light on economic significance of variance factor model.
“Subnational Credit Risk and Sovereign Bailouts—Who Pays the Premium?” with Eva Jenkner, working paper
Studies have shown that markets may underprice subnational governments’ credit risk on the implicit assumption that the subnational entity would be bailed out by the central government in case of financial difficulties. However, the question of whether a sovereign pays a premium on its own borrowing as a result of (implicitly or explicitly) guaranteeing its sub-entities has yet to be explored. We use an event study approach with separate equations for two levels of government to test for an increase in sovereign risk premia and a simultaneous decrease in subnational risk premia—or a de facto transfer of risk from the latter to the former—as a sovereign bailout is announced. Using daily financial market data for Spain and its autonomous regions from January 2010 to June 2013, we find support for our risk transfer hypothesis. We demonstrate that the sovereign spread increased by around 70 basis points as a result of the central government’s support for fiscally distressed autonomías.
“Risks of the Carry Trade,” with Kent Daniel and Robert Hodrick, work in progress
We examine the returns to various carry trade portfolios formed from G10 currencies. We find that Sharpe ratios of carry trades range from 0.36 to 0.78 when varying the choices of the benchmark currency. Risk matters, as a dollar-neutral carry trade has an insignificant alpha in the Fama-French three-factor model (FF3). The weighting of currencies also matters, as spread-weighted or risk-rebalanced carry trades exhibit significant alphas that cannot be explained by the Fama-French three-factor model or the two-factor FX model. When hedged with options, such portfolios still earn significant alphas against the Fama-French three-factor model while exhibiting little skewness. Lastly, we use the daily returns to calculate the maximum losses for different horizons. We find that the maximum loss over one month or one quarter rejects the i.i.d. assumption underlying a bootstrap at the 5% level, indicating that autocorrelation in the downside may contribute to the negative skewness of the longer horizon returns.