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Working Papers

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

Abstract: Currencies in emerging markets with stricter capital controls exhibit lower average returns. Traditional currency risk factors do not explain these return spreads. The impact of capital controls is more prominent in debtor countries and not present in advanced economies. Additionally, high-capital-control-currencies experience less depreciation during times of high global risk, as measured by VIX. These findings align with the macroprudential view of capital controls. We propose an equilibrium intermediary-based asset pricing model where a country borrows subject to an occasionally binding credit constraint. Capital controls can lower the probability of crises and mitigate currency crashes during these times. The model quantitatively explains the empirical findings and quantifies the financial impact of non-precuniary externality and the effectiveness of capital control policies in restoring efficiency.

(Presentation: 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)
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: 2023 CICF, 2022 AFBC, seminar at HKU, UNC, SMU, NTU)

3.  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

4. 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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