Working Papers

1. Currency Risk under Capital Controls (with Xiang Fang and Yang Liu) [SSRN]

(Journal of International Economics, Revise and Resubmit)

Abstract: Currencies in emerging markets with stricter capital controls exhibit lower average returns, unexplained by standard currency risk factors. This relation is pronounced in debtor countries with high foreign currency liability shares. Capital controls mitigate currency risk by preventing depreciation during market turmoil. We propose an intermediary asset pricing model incorporating an occasionally binding credit constraint for borrowing countries. Capital controls lower crises probability and reduce currency crashes. The model replicates the empirical findings and quantifies the financial impact of pecuniary externality. Based on the model, currency risk premia serve as a tool for policy evaluation.

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(Presentation: 2024 CAFM, 2024 SFS Cavalcade AP, 2024 EEA, 2023 VSFX, 2023 WFA, 2023 NASMES, 2023 ABFER, 2023 HEC-McGill Winter Finance Workshop, 2023 FDU (CFAM-ARX Paper Award), 2022 EFA, 2022 CICF, 2022 CFRC, 2022 CICM, 2022 AMES Tokyo, 2022 AMES Shenzhen, 2022 AsianFA, seminar at HKU, HKUST, ZJU, SWUFE)

2. Dollar and Carry Redux (with Thomas Maurer, Andrea Vedolin and Yaoyuan Zhang) [SSRN]
Abstract: Contrary to existing literature, we establish that two factors, dollar and carry, suffice to explain a large cross-section of currency returns with R-squared exceeding 80%. Our paper highlights the importance of accounting for time-variation in conditional moments. Unconditional estimations that ignore this time-variation mistakenly reject the two-factor model. We propose a parsimonious framework to estimate conditional currency factor models and provide testable restrictions. Our findings imply that currency markets are well described by a model in which (i) each country-specific SDF loads on one country-specific--dollar--and one global--carry--shock, and (ii) risk loadings are time-varying. Other risk factors proposed in the literature are useful to describe the time variation in dollar and carry factor risk premia.
 

(Presentation: 2025 SFX, 2025 SGF, 2025 MFA, 2024 AsianFA, 2024 FIRS, 2024 SFS Cavalcade NA, 2023 CICF, 2022 AFBC, seminar at HKU, UNC, SMU, NTU)

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3.  Mandatory ESG Disclosure and Cost of Bank Loans: International Evidence (with Wendi Huang)

Abstract: In this paper, we examine the impact of ESG regulation on firms' cost of bank loans within an international sample of 56 countries. Employing a staggered Difference-In-Difference approach, we find uniform evidence that firms subject to mandatory ESG disclosure laws experience significantly lower bank loan spreads compared to firms not exposed to such regulations. This effect cannot be explained by alternative forces including ESG performance and green finance development. We demonstrate that the reduction in firms' borrowing costs associated with mandatory ESG disclosure is driven by the mitigation of information asymmetry between firms and banks.

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4.  Sustainable Regulation, Stronger Currencies: Evidence from Capital Flow Dynamics (with Wendi Huang)

Abstract: Using a staggered Difference-in-Difference approach across 48 countries, we find that currencies of nations with more stringent Environment, Social, and Governance (ESG) regulations yield higher returns. The increase in currency return stems from growth in net capital flow, which is primarily driven by a significant reduction in capital outflow, especially in portfolio investments. While changes in the ESG regulatory environment introduce uncertainty to the economy, investors value the alleviation of information opacity and, more significantly, the mitigation of ESG-related risks. Our findings highlight the potential of ESG regulation as an effective policy tool to enhance financial stability and attract capital by reducing perceived risk and information asymmetry in international currency markets.

5.  Roles of Global Banks in Local Asset Markets under Regulations
Abstract: Stronger regulations in fact enhance roles of global banks as marginal investors in the local asset markets. After the Global Financial Crisis, leverages of global banks become significant in predicting asset returns in local markets where their subsidiaries are located, while are muted in pre-crisis period. This transmission of roles of global banks is motivated by the positive funding advantage in local currency for dollar lenders through the FX swap market as a consequence of tighter balance sheet constraints imposed on global banks under the Basel III framework. For global banks with higher capital requirement, the effect of funding advantage is stronger. A two-bank two-currency model is proposed to justify the empirical findings.

 

Work in Progress

6. Return Predictability (with Thomas Maurer and Yaoyuan Zhang)
Abstract:  We introduce a novel non-parametric approach to estimate the return predictability of assets. The amount of return predictability is identified in a decomposition of the unconditional return variance into the expected conditional variance and the variance of conditional expected returns. We estimate the conditional variance with the range-based methods, whose advantage is drift independence. Outliers can be an issue for the range-based variance estimator, which could be addressed by a filter we introduce. We use simulations to validate our approach.

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7. On Choosing Currency Factors (with Yan Wang and Lingxiao Zhao)

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