Working papers
(Draft available upon request)
Presentations: Market Microstructure Summer School, Warwick Business School
Abstract
This paper develops a game-theoretic model of endogenous liquidity fragmentation in decentralized exchanges with automated market makers. Liquidity providers strategically create competing pools, while traders optimally split orders across pools by balancing price impact and gas fees. When gas fees are sufficiently small, no pure-strategy equilibrium exists because entry by additional pools is always profitable. For intermediate gas fees, multiple fragmented equilibria may coexist. For sufficiently large gas fees, fragmentation collapses and the market converges to a unique one-pool equilibrium. We then show that front-running creates an additional motive for fragmentation: by splitting orders across pools, traders reduce rents extractable through sandwich attacks. Thus fragmentation can arise as a defensive response to predatory transaction ordering. The equilibrium degree of fragmentation is endogenously determined by the interaction of gas fees, entry incentives, and front-running risk.
Belief Granularity, Market Liquidity and Price Efficiency, with David Storey
(Draft available upon request)
Presentations: Market Microstructure Summer School, FMA Asia, Warwick Business School
Abstract
We model investors’ decisions to use coarse thinking to process information and the effects of this on asset markets. Agents with weak priors may choose to pool together their signals across assets to mitigate the problem of overfitting. This model of coarse information processing helps explain features of return comovement in markets that are hard to explain with existing models based on rational expectations or limited attention. Theoretically and empirically, we demonstrate a link between return comovement and return predictability.
Debt-to-EBITDA, Cost of Capital and the Trade-off Theory, with Pengguo Wang
(Draft available upon request)
Abstract
In this paper, we propose a unified model framework to directly derive a firm-specific measure of the expected weighted average cost of capital. Our results support the trade-off theory at the industry level and the presence of an optimal debt usage zone. The analysis provides evidence of the U-shaped (inverted U-shaped) relationship between the cost of capital (the market value of the firm) and the debt usage for unregulated industries. The use of Debt/EBITDA as the debt usage metric yields the most striking results, outperforming traditional measures such as debt-to-asset ratios in both book value and market value terms. Our evidence supports that firms with a low cost of capital invest more, and that firms with high unlevered beta have a high cost of capital.
The Synthetic Price-to-Forward Earnings Multiple and Its Applications, with Pengguo Wang
(Draft available upon request)
Abstract
Practically used price multiples are largely disconnected from theoretically sound discounted cash flow valuation models. In this paper, we introduce a ‘synthetic price-to-forward earnings multiple’ that utilizes a firm’s economic and accounting fundamentals, as well as key drivers of value in construction. We propose an approach to estimate the relevant parameters simultaneously. The synthetic price multiple provides an additional tool for valuing stocks and predicting stock returns. We find that the value estimates from our synthetic price-to-forward earnings multiples are less biased than the often-used valuation models and price multiples. The difference between synthetic and actual price-to-forward earnings multiples has important implications for equity investments. Longing firms with the lowest actual-to-synthetic price multiples and shorting those with the highest gaps can generate statistically and economically significant hedge returns.
