The Joint Determination of Haircut and Spread of Collateralized Loans in Shadow Banking
Management Science, Forthcoming.
This paper examines the joint determination of haircuts and interest rates for collateralized loans in shadow banking within a general equilibrium model. Three results emerge. First, higher downside quality (the distribution of future collateral payoffs below the debt face value) reduces haircuts only under certain conditions while higher upside quality (the distribution of future collateral payoffs above the debt face value) always increases them. Second, the relative insensitivity of interest rates to shocks, compared to haircuts, occurs when shocks affect only the upside collateral quality and can also arise endogenously, with changes in haircuts amplified and changes in interest rates dampened. Third, when depositors’ saving needs increase, interest rates unexpectedly rise while haircut requirements are relaxed. The same effects occur when banks’ collateral supply shrinks.
BankScope Prize for the best paper in Banking at AFBC, UNSW
Presented at Cowles GE Conference (Yale SOM), AEA, CICF, CFEA, USC Marshall PhD Conference in Finance, AFBC PhD Forum, RBNZ
Disclosure Regulation, Cost of Capital, and Firm Values
Journal of Accounting and Economics
This paper shows that mandating some firms to disclose more while leaving other firms disclosing voluntarily is less effective in improving and may even harm the overall information environment when firms’ disclosures are endogenous. Although the regulated firms’ increased disclosure directly reduces all firms’ cost of capital, it crowds out the unregulated firms’ voluntary disclosure and thus increases all firms’ cost of capital indirectly. Under certain circumstances, the negative indirect effect can outweigh the direct benefit. These results are consistent with the scant evidence on the cost-of-capital effect of mandatory disclosure. The model highlights the importance of the market-wide effects of disclosure regulation and facilitates quantitative cost-benefit analyses for specific regulatory proposals.
Hao, Jinji, 2024, Disclosure Regulation, Cost of Capital, and Firm Values, Journal of Accounting and Economics, 77 (1), 101605. https://doi.org/10.1016/j.jacceco.2023.101605.
GARCH Option Pricing Models, the CBOE VIX and Variance Risk Premium
with Jin E. Zhang
Journal of Financial Econometrics
In this article, we derive the corresponding implied VIX formulas under the locally risk-neutral valuation relationship (LRNVR) proposed by Duan (1995) when a class of square-root stochastic autoregressive volatility (SR-SARV) models are proposed for S&P 500 index. The empirical study shows that the GARCH implied VIX is consistently and significantly lower than the CBOE VIX for all kinds of GARCH model investigated when they are estimated with returns only. When jointly estimated with both returns and VIX, the parameters are distorted unreasonably, and the GARCH implied VIX still cannot fit the CBOE VIX from various statistical aspects. The source of this discrepancy is then theoretically analyzed. We conclude that the GARCH option pricing under the LRNVR fails to incorporate the price of volatility or variance risk premium.
Hao, Jinji, and Jin E. Zhang, 2013, GARCH Option Pricing Models, the CBOE VIX and Variance Risk Premium, Journal of Financial Econometrics, 11 (3), 556-580
Asset Pricing with Option-implied Consumption Growth
Doing equilibrium asset pricing using the investors' expected consumption growth extracted from the option prices delivers superior performance not only in terms of matching the levels of equity risk premium, risk-free rate, and volatility but also in terms of return predictability, volatility forecasting, and matching the dynamics of risk-free rate.
A Model-Free Tail Risk Index and Its Return Predictability
Presented at 2016 Colorado Finance Summit, 2017 SoFiE
This paper proposes a tail risk index, TIX, as the growth rate of the model-free cumulant generating function of market risk calculated from index option prices. It captures the power law decay rate of the left tail of future return distributions and thus reflects market beliefs about the chance of a market crash. The change in these beliefs strongly predicts market returns both in and out of sample, with monthly R2 statistics of 3.33% and 6.15%, respectively. It can generate utility gains of over 8% per annum for a mean-variance investor. Evidence at the market and industry levels indicates informational frictions between options and spot markets with about one-third of the information content of this change in market beliefs being delayed to be incorporated into spot prices. A decomposition of VIX into its normal risk and tail risk components shows that only the change in tail risk, which accounts for on average 5% of risks measured by VIX, has return predictability.