Embedded Files
Mirela Sandulescu, Paul Schneider
We introduce the nonlinear arbitrage correction (NAC), the residual that renders a linear benchmark model arbitrage-free while preserving the law of one price. The price of NAC captures the marginal Sharpe ratio increase consistent with no-arbitrage and upper-bounds the constrained Hansen–Jagannathan distance. Using four decades of international equity, currency, and factor returns, NAC is strongly countercyclical, peaking during crises when linear models turn negative. The implied Sharpe ratio increase reaches 0.3, underscoring its economic relevance. While linear models perform well on average, they fail in distressed states, underpricing nonlinear payoffs. Incorporating NAC restores positivity and stabilizes pricing across regimes.
Forthcoming, The Review of Financial Studies
Winner of the Best Paper Award, 2023 Annual JHU Carey Finance Conference
Mirela Sandulescu, Fabio Trojani, Andrea Vedolin
We provide a theoretical framework to uncover in a model-free way the relationship between international stochastic discount factors (SDFs), stochastic wedges, and financial market structures. Exchange rates are in general different from the ratio of international SDFs in incomplete markets, as captured by a stochastic wedge. We theoretically show that this wedge can be zero in incomplete and integrated markets. Market segmentation breaks the strong link between exchange rates and international SDFs, which helps address salient features of international asset returns, while keeping the volatility and cross-country correlation of SDFs at moderate levels.
Journal of Finance (2021) , 76(2), 935-976.
Mirela Sandulescu
I propose a model-free measure of the extent of relative market integration between U.S. corporate bonds and stocks of their issuers. My measure is both consistent with no-arbitrage and financial frictions, and quantifies pricing consistency across markets. I document that trading frictions, often imposed on market participants, including transaction costs and short-selling constraints, yield realistic optimal portfolio positions. Overall, my evidence indicates U.S. stock and corporate bond markets are non-trivially integrated, by an extent between 50% and 90% of a model-free full-integration benchmark, depending on the severity of financial frictions, firm characteristics, and the risk-bearing capacity of financial intermediaries.
Paolo Pasquariello, Mirela Sandulescu
Canonical theories of trading assume that asset payoffs are linear in fundamentals. We propose that nonlinearity of equity and corporate bond payoffs (via issuer solvency) has novel effects on their price formation. We show that informed risk-neutral speculation trades strategically in stocks and bonds by their relative sensitivity to firm value, a function of perceived default probability. As that probability changes so does the relative intensity of speculation (and adverse selection), yielding differential stock and bond liquidity and non-monotonic stock-bond price comovement. We find supportive evidence within a comprehensive sample of intraday U.S. stock and corporate bond trades and prices.
Winner of the XiYue Best Paper Award, 2023 China International Conference in Finance
R&R
Thummim Cho, Riccardo Colacito, Lukas Kremens, Mirela Sandulescu
We propose a new method to construct model-implied exchange rates. Contrary to popular exercises with currency returns, we study currency pricing in levels. Our approach allows us to compare currency misvaluations relative to different pricing models and decompose exchange rate variance into fundamentals, risk premia, and model-implied misvaluation. We show that different factor exposures explain different currency phenomena: overvaluation vis-a-vis dollar+carry predicts crashes in high-interest currencies, whereas market+value predicts skewness in safe-haven returns and rationalizes recent gold appreciation. Further, risk-adjustment is crucial in assessing exchange rates for potential manipulation: a naive risk-neutral model points to undervaluation in the Chinese yuan, but accounting for exposures to dollar, carry, and value factors rationalizes observed prices.
Paola Pederzoli, Mirela Sandulescu
We investigate the cross-section of option returns using a model-free approach, by constructing a stochastic discount factor (SDF) that features minimal variance and accounts for frictions. We find that incorporating transaction costs in the form of bid-ask spreads is essential in order to obtain realistic positions in the optimal trading strategy that mainly invests in in-the-money call options. Empirically, we show that the out-of-sample pricing errors of the constrained SDF are 90% lower than the ones implied by the benchmark unconstrained SDF. Our findings document a strong link between the optimal portfolio accounting for transaction costs and the option positions held by public investors (non-intermediaries). This result suggests that public investors are the marginal investors in the options market. Finally, we show that the trading activity of customers in in-the-money call options has significant explanatory power for the cross-section of individual equity option returns.
Mirela Sandulescu
This study investigates the relations between disclosure tone, insider trading and returns. Using a dictionary-based approach to quantify the disclosure tone contained in the Management Discussion and Analysis of 10-Q and 10-K filings, I find that the net disclosure tone predicts the insider purchase ratio (purchases scaled by the sum of purchases and sales), even after controlling for past purchases, return volatility and firm characteristics. Constructing a buy-and-hold portfolio over a six months horizon, I find that insiders earn approximately 5.8% abnormal return per year. Both disclosure tone and insider purchase ratio are able to predict the buy-and-hold abnormal return.
Studies in Communication Sciences 15 (2015) 12 - 36
Google Sites
Report abuse