2024

We extend the valuation of contingent claims in the presence of default, collateral, and funding to a random functional setting and characterize pre-default value processes by martingales. Pre-default value semimartingales can also be described by BSDEs with random path-dependent coefficients and martingales as drivers. En route, we relax conditions on the available market information and construct a broad class of default times. Moreover, under stochastic volatility, we characterize pre-default value processes via mild solutions to parabolic semilinear PDEs and give sufficient conditions for mild solutions to exist uniquely and to be classical.

Models of learning about economic crises generate risk premia that rise at the onset of a crisis but then fall as belief uncertainty fades. Yet, empirical risk premia remain elevated during crises. We resolve this tension with leverage dynamics generated by the impact of learning on optimal capital structure decisions within a representative agent consumption-based model. Optimal leverage creates a feedback effect: learning increases risk premia, thereby depressing prices and further raising leverage. We structurally estimate the model and show it closely matches the joint dynamics of consumption, equity risk premia, credit risk, and leverage, especially during crises.

An extensive literature supports that a cross-sectional momentum strategy, going long winners and short losers’ stocks, yields substantial abnormal returns. This evidence challenges conventional asset pricing theories and has been considered important evidence against the EMH. Our study reveals that the classic momentum effect has almost disappeared in the last 25 years. We collected data on short interest to investigate the role played by short-selling frictions in this market evolution. Controlling for short interest, the momentum effect re-emerges very persuasively, even in the latest period. These novel results align with the DSGE framework proposed by Scheinkman and Xiong (2003), linking short-selling constraints to the dynamics of asset pricing and aiding in the understanding of the economics of cross-sectional momentum.