Xiao Xiao

Assistant Professor (non-tenure-track) at Erasmus School of Economics in Erasmus University Rotterdam

My research interest covers empirical asset pricing, derivatives, and financial econometrics.

Address: ET-01, Burgemeester Oudlaan 50, 3062 PA, Rotterdam, the Netherlands

E-mail: xiao at ese.eur.nl

I will be available for interviews at European Job Market 2019 (Rotterdam) and AFA 2020 (San Diego)

Revise & Resubmit at Journal of Financial and Quantitative Analysis

CICF 2019, EFA 2018, AsianFA 2018

We find that separating the higher-order risk premium from the pure variance risk premium can significantly improve the stock market predictability, with R-squared up to 14 percent for the 3-month horizon. This finding proves to be economically significant in an asset allocation exercise, becomes even stronger for the portfolio returns of the momentum factor, and survives a series of robustness checks. We show that a consumption-based asset pricing model with rare events can generate the predictability afforded by higher-order risk premium.

AFA 2020 (Scheduled), 2019 FMA Conference on Derivatives and Volatility (Scheduled), Concordia University (Scheduled), HEC Montreal (Scheduled), NYU Shanghai Volatility Institute Conference (Scheduled), WFA 2019, NFA Charlevoix 2018, Optionmetrics Conference 2018

This paper studies the effects of default risk on equity option returns. Under a stylized capital structure model, expected delta-hedged equity option returns have a negative relation with default risk, driven by firm leverage, asset volatility, and debt maturity. Empirically, we find that delta-hedged equity option returns monotonically decrease with higher default risk measured by credit ratings or default probability. We also find that default risk drives the predictability of existing anomalies in the equity option market. For all ten anomalies, the long-short option returns are higher for high default risk firms.

AFA 2020 (Scheduled), ES Winter Meeting 2020 (Scheduled), Vienna Symposium on Foreign Exchange Markets, AsianFA 2019, HEC Montreal, University of Montreal

Project funded by Canadian Derivatives Institute

We find that a US equity tail risk factor constructed from out-of-the-money S&P 500 put option prices explains the cross sectional variation of currency excess returns. Currencies highly exposed to this factor offer a low currency risk premium because they appreciate when US tail risk increases. In a reduced-form model, we show that country-specific tail risk factors are priced in the cross section of currency returns only if they contain a global risk component. Motivated by the intuition from the model and by our empirical results, we construct a novel proxy for a global tail risk factor by buying currencies with high US equity tail beta and shorting currencies with low US tail beta. This factor, along with the dollar risk factor, explains a large portion of the cross sectional variation in the currency carry and momentum portfolios and outperforms other models widely used in the literature.

AFA 2020 (Scheduled), EasternFA 2019, MidwestFA 2019, SFS Calvacade Asia Pacific 2018, NFA 2018, CICF 2018, IFSID (CDI) conference 2018.

This paper studies the relation between the uncertainty of volatility and future delta-hedged equity option returns. We find that delta-hedged option returns consistently decrease in uncertainty of volatility. Our results hold for different measures of volatility such as implied volatility, EGARCH volatility from daily returns, and realized volatility from high-frequency data. The results are robust to firm characteristics, stock and option liquidity, volatility characteristics, jump risks, and are not explained by common risk factors. Our findings suggest that option dealers charge a higher premium for single-name options with high uncertainty of volatility, because these stock options are more difficult to hedge.

NFA 2019, Vrije University Amsterdam, ABS@University of Amsterdam (Scheduled), Annual Early Career Women in Finance Conference, (ECWFC@WFA), Singapore Management University, Chinese University of Hong Kong, City University of London

Project funded by Canadian Derivatives Institute

Option implied volatility change has significant cross-sectional predictive power for the underlying firms’ bond returns. Corporate bonds with large increases in implied volatilities over the past month underperform those with large decreases in implied volatilities by approximately 0.6% per month. The results are robust to various bond characteristics and volatility related variables, as well as to stock and bond factor models. Our results are consistent with the notion that informed traders with new information about default risk prefer to trade in the option market, and that the corporate bond market is slow in incorporating that information.

FMA 2019, CICF 2019, EasternFA 2019, MidwestFA 2019

Project funded by Canadian Derivatives Institute

This paper studies the factor structure in the cross-section of delta-hedged equity option returns. Using latent factor techniques, we find strong evidence for the existence of a factor structure in equity options returns. We propose a four-factor model, which captures relevant latent factors and explains the time series and cross-section of equity option returns. The factors are the market volatility risk factor and three characteristic-based factors related to firm size, idiosyncratic volatility, and the difference between implied and historical volatilities. Stock return factors cannot price the cross-section of equity option returns.

Publication

Journal of Empirical Finance, Vol. 47, No. 207--228, 2018