Empirical Asset Pricing 35905
Prof. John H.Cochrane
email@example.com HPC459 702 3059
Latest update: Feb 28 2011 .
NOTE: some of the links on this page have broken with the passage of time. I'll fix them if and when I teach the class. In the meantime, if you find a broken link just google the paper instead.
Documents - problem sets, lecture notes, etc.
Friday problem sets
1. Send it by email firstname.lastname@example.org 2. leave it in Rui's folder in Rosenwald 2nd floor, by 3.30pm
We WILL have a class Mon Jan 17. Really, do you want to try to reschedule? You will need a booth id to get in the door. Rui will be by the main door 5807 S. Woodlawn 8:20-8:30 to let in anyone who doesn't have a card.
Class Meeting Times: M 8:30-12:00 C09
Review Wed 8:30-10 3A
No friday class. We'll do a three hour class on mondays. There was no way to get around conflicts
Exam: Finals week, C09 M 8-11 Per booth exam schedule
First I survey facts, then theories
constructed to understand the facts.
The class will center on reading and discussion of articles
and problem sets. You must read and think about the readings before class, and
be ready to discuss the readings in class. I will call on you and occasionally
ask students to lead discussions on papers or parts of papers. You should be
ready to do this.
Grades will reflect class participation, homework, and a
final exam. The final exam takes place as per the Booth final exam schedule.
Bring a name card to every class if you
want class participation grades or me ever to learn your name.
Write your own problem set. You may talk to anyone you want
while doing problem sets.
You will need a copy of my Asset Pricing, preferably the revised edition with no (known)
typos. The articles will be available as pdfs from
the class website. You need to be able to do empirical work. I recommend matlab and can help with it, but use what you want. You
need to be able to get crsp data from wrds. Figure out how to do it.
Prerequisites: I don't enforce strict prerequisites. I
presume everyone has taken either my or Ralph Koijen's
35904 or George Constantinides' 35912, and a large part of the first-year PhD
micro and macro sequences. If you haven't taken finance before, at least really
read Ch1 of Asset Pricing carefully before class starts.
Rules: Note some problems are similar to previous year's
problems. Using previous year programs or solutions is a major honor code
violation. There are enough changed numbers, changed questions, typos and mistakes in previous
solutions, that it will take more time to use those than to start fresh.
Class Documents - problem sets, lecture notes, etc.
Problem set 1 - due Mon week 2
Problem set 1 answers Yes, I meant "consistent" not "unbiased".
Olsgmm function called by program
Data files: wvr sbbi cay vwr and sbbi updated 12/28/2011. Note my program is set up with data files in a different directory. Modify the
load statements according to where you put data.
Problem set 2 - due Mon week 3
Problem set 2 answers
Problem set 3 questions. Due Friday
Problem set 3 answers
Program Also uses vwr from above
Problem set 4 1/29 questions Due next Friday
Problem set 4 answers
Overheads The pictures I showed
in class. Updated 1/23/2011
Lecture notes. On stock predictability. Beginning through the dog that didn't bark. Updated 1/23/2011. Cleaned a bit, and includes the way I presented things in lecture 2011.
Disclaimer: These are my notes. They are not a substitute for doing the readings, and they certainly are not
a substitute for showing up in class! They will help you if you miss a point in
class. They are not written well. I also massively over-prepare, so I will not cover in
class every point made in the notes.
Bonds and FX overheads 2/7/2011 update, reflects class 2/7,
Bonds notes 2/7/2011 update,
FX notes 2/14/2011
Problem set 5 questions At last! Worth the wait.
Problem set 5 Answers
Fama-French Overheads 2/21
Empirical methods notes. Time series, cross section, and eigenvalue decompositions 2/21
Problem set 6 2/21
portfolio returns data 2/21
Problem set 6 answers 2/28
Problem set 7 questions.2/28
(Also use Fama French 25 portfolios and factors above)
Problem set 7 answers;
Other beme data used in my program 3/7
Notes on Frictions and Financial Crisis. From Lamont&Thaler to Duffie 3/7
---- End of active Class Documents links --------
Fama-French notes 2/25 update includes empirical methods notes,and a derivation of eigenvalue factor models by popular request
Production notes 3/3 update3/8
Frictions and financial crisis notes 3/10
Slides on financial crisis (lots and lots of pretty pictures) 3/10
Final exam review problems 3/10 Revised 3/13 to fix the mistake in the answers to stock predictability question 1
Final exam answers 3/18
equity premium and lightning m* review
International risk sharing and Habits
Notes update habit
notes, and notes on utility functions
Notes on investment and
I expect you to read the
"main" readings closely. There are some "reference" readings which contain
material I'll talk about in class and additional papers you should know about,
but I don't expect you to read them.
- Discount Rates; talk and slides. The "talk" is the speech I'm giving at the AFA meetings, "Discount rates" is a draft of the underlying paper. It's also an outline of pretty much everything we're goinig to do this quarter.
Week 2-3: Return predictability, long horizons, volatility, bubbles, present value
relations, price and return decompositions, VAR representation, univariate mean-reversion.
I have only assigned the
"summary" version of predictability, but of course I hope someday you'll sit
down and look at some of the originals, especially mine.
- Fama, Eugene F., and Kenneth R.
French, 1988, "Dividend yields and expected stock returns," Journal of Financial Economics, 22,
3-25. The regression of returns on D/P, and long horizons.
- Shiller, Robert. 1981, "Do Stock Prices
Move Too Much to be Justified by Subsequent Changes in Dividends?," The American Economic Review, 71, 421-436. I'll show the graph in
class. This is the "volatility test" which at first looked like something new,
but turned out to be the same thing as long-run return predictability.
- Cochrane, John H., Volatility
Tests and Efficient Markets: A Review Essay" Journal of Monetary Economics 27 (May 1991) 463-485. Ostensibly a
review of Shiller's book. In fact, I sorted out
bubbles and the connection between volatility tests and return forecasts.
- Cochrane, John H., Explaining the Variance of Price-Dividend Ratios" Reviewof Financial Studies (1992) 5:2, 243-280. This
is the variance decomposition for d/p I showed in class.
- Cochrane, John
Review. Peter M. Garber, Famous First Bubbles: The Fundamentals of Early Manias." Journal of Political Economy 109, (October 2001), 1150-1154. This is
pure fun. It turns out the early "bubbles" weren't.
- Cochrane, John
and Transitory Components of GNP and Stock Prices" Quarterly Journal of Economics CIX (February 1994) 241-266 This is the
impulse-response function we studied in class. In the end cointegrating vectors are really good ways to measure long-run responses.
- Cochrane John H., How
Big is the Random Walk in GNP?" Journal of Political Economy 96 (October
1988) 893-920. A warning you should keep in mind, that low-order VARs can be terrible ways to measure long-run responses. The presence of a cointegratinig vector in "Permanent and transitory" seems to be a key for decent long-run performance from short-run models.
Campbell Classics: The linearized present value
relation, and some of his contributions to the stock predictability literature.
(There's lots more on Campbell's website.)
- Campbell, John Y.
and Robert J. Shiller, "Cointegration and Tests of
Present Value Models" Journal of Political Economy 95, 1062–1088,
John Y., and Robert J. Shiller, "The Dividend-Price Ratio and Expectations of
Future Dividends and Discount Factors", Review of Financial Studies 1:195–228,
- Campbell, John
Y., and John Ammer, "What Moves the Stock and Bond
Markets? A Variance Decomposition for Long-Term Asset Returns", Journal of
Finance 48:3–37, March 1993.
Week 4a: Econometric issues in return
Week 4b Bond return predictability
- Cochrane, John H., Asset Pricing Ch. 20.1
"Bonds" and "Foreign Exchange" p. 389-435.
- Cochrane, John H. and Monika Piazzesi, Bond
Risk Premia March 2005, American Economic Review 95:1,
138-160. Appendix ; Overheads
- Cochrane, John H. and Monika Piazzesi 2008, Decomposing
the Yield Curve, Manuscript. This paper merges what we learned about
predictability with an affine model.
- Fama, Eugene F., 1986, "Term Premiums and Default Premiums in Money Markets." Journal of Financial Economics 17, 175-96. There are amazingly few regressions analyzing credit spreads. How much time-series and cross-sectional variation in credit spreads reflects default, and how much measures risk premium? It's a good 2nd year paper topic!
- Francis A. Longstaff, Kay Giesecke, Stephen Schaefer and Ilya Strebulaev. (March 2010). "Corporate Bond Default Risk: A 150 - Year Perspective.'' Some basic facts, spreads correspond to returns not default. But there are lots of defaults!
Week 5a FX
- Cochrane, John H., Asset Pricing Ch. 20.1
"Bonds" and "Foreign Exchange" p. 389-435.
- Lustig, Hanno, Nikolai
L. Roussanov, and Adrien Verdelhan, 2009, "Common Risk Factors
in Currency Markets," Manuscript UCLA. Up through p. 15 only. This is quick but cool. Rather than run
regressions, sort in to portfolios and look at means; then eigenvalue
decompose the portfolio covariance matrix. It makes the connection between
regression and Fama-French procedures.
- Jurek, Jakub, 2008, "Crash-Neutral Currency Carry Trades," Manuscript
Princeton University. This paper also goes on and on, so don't try to read it all.
I will show in class Table I, II; VI-IX, ;
Figure 1, 3, 8. These update the UIP regressions, show you what happens if you
add put option protection, and show what happened in the big crash.
Week 8 Cross-sectional facts Size, B/M, momentum, accounting sorts, in
expected returns and covariances
- Cochrane, Asset Pricing , Ch. 20.2 p. 435-454.
- Fama Eugene F. and Kenneth R. French 1996 "Multifactor Explanations of
Asset Pricing Anomalies," Journal of Finance 51, 55-84. Really
understand Table I, sales rank in Table II, II, Table VI and VII. Also read p.
75 on, "interpreting the results."
- Fama, Eugene F., and Kenneth R. French 2006, "Dissecting
Anomalies" Journal of Finance 63 (4) 1653-1678. Understand the tables. These two are probably the most important papers in all asset pricing!
- Asness, Cliff, Toby Moskowitz and Lasse
Pedersen, June 2009, "Value
and Momentum Everywhere" Manuscript, University of Chicago. The latest on
value and momentum, and how they are correlated across countries and asset
- Lettau, Martin and Sydney Ludvigson, 2001, Resurrecting the (C)CAPM: A Cross-Sectional
Test When Risk Premia Are Time-Varying The Journal
of Political Economy, Vol. 109, No. 6 (Dec., 2001), pp. 1238-1287. The first
figure says it all, no need to go much further. There is an industry that
prices the FF 25 with ICAPM or macro models. Often the papers are a bit fishy –
huge factor risk premia, small spread in betas, 10
factors to explain 3 premiums. I'll just show Figure 1 here and make a few
comments. But I wanted some placeholder for this massive literature. (We since figured out that pricing the 25 isn't very interesting.)
- McCloskey, Deirdre (then Donald), 1983, ,The Rhetoric of Economics 21, 481-517. This is the article I mentioned that helps to understand why Fama and French are so successful despte needing exponential notation to describe probability values. Easy but very provocative reading.
Week 9/10a Short sales
and liquidity; securities with value in trading; order flow and prices
We just had a huge financial crisis. We can only scratch the surface, but
this will frame so much research for the next few years I can't leave it out. Liquidity,
bank runs, "flight to quality," short constraints, funding constraints,
mortgages, regulatory arbitrage, the idea that stock prices could
be driven down when hedge funds were forced to liquidate, lots of little "arbitrages,"
including different prices for bonds and CDS, violations of covered interest
parity, a huge on the run/off the run spread, the idiocy of writing put options and calling
it "arbitrage," and so on. This should be a a whole course, and I'm sure some day it will be.
Many (most) of the facts and ideas springing from the financial crisis
are not new, but just bigger versions of old puzzles. For this reason, we'll
read some pre-crisis papers that bear on the same issues.
- Lamont Owen, and Richard Thaler 2003, Can the Market
Add and Subtract?: Mispricing in Tech-Stock Carve-Outs Journal of Political Economy 111:
227-268. A really nice mis-pricing. Two ways of
getting 3-com stock trade at different prices.
- Cochrane, John H., Stock
as Money: Convenience Yield and the Tech-Stock Bubble in William C.
Hunter, George G. Kaufman and Michael Pomerleano,
Eds., Asset Price Bubbles Cambridge: MIT Press 2003. An answer to Lamont and
Thaler. Money and bonds are also two
ways to get the same thing at different prices, and they look a lot like the
two ways of getting 3 com stock.
- Brandt Michael and Kenneth A. Kavajecz, 2004, Price Discovery in the U.S. Treasury
Market: The impact of Orderflow and Liquidity on the
Yield Curve Journal of Finance 59,
(Dec) 2623-2654. (For class, you can stop reading at section III p. 2644). This
is a great paper. The price of A changes when there is
order flow of B, suggesting that information leads to orderflow,
not orderflow mechanically moves prices.
I'll present results from these in class.
- Francis A. Longstaff
2004, "The Flight to Liquidity
Premium in U.S. Treasury Bond Prices Journal of Business 77, 511-526, 2004, Contrasts
treasury bonds with identical Refcorp bonds to
isolate the liquidity premium.
Fall 2008 saw the same sort of thing 10 times larger.
- Mattias Flecenstein, Francis Longstaff and Hanno Lustig, 2010, "Why does the Treasury Issue Tips?" A huge arbitrage between treasury and tips, illustrating perhaps some liquidity issues. Read the description of the trade, see Figure 1
- Arvind Krishnamurthy and Annette Vissing-Jorgenson, 2010, "The Aggregate Demand for Treasury Debt" Just look at Figure 1. There seems to be a "money" like demand for all treasury debt.
- Cochrane, John, 2004, Liquidity,
Trading and Asset Prices, NBER Reporter This is an
overview paper. It gives my organizing thoughts on both theory and empirical
work and covers some papers we won't read directly.
Week 10b Financial
- Brunermeier, Markus,
2009, Deciphering the Liquidity and Credit Crunch 2007-2009Journal of Economic Perspectives 23
77-100. (Optional longer version NBER working paper with more graphs). I will only cover the facts and chronology.
- Gorton, Gary B., and Andrew Metrick, 2009, Haircuts, NBER Working Paper 15273. The
heart of the "crisis" was a run on short term debt, and the fact that suddenly
all sorts of debt was not accepted as collateral. Read about it here. This is also excellent on how short-term debt works, and offers a well-explained alternative and diametrically opposed view to the Diamond-Rajan view that short-term debt is necessary to discipline managers. Here, short-term debt is useful precisely because you do not have to do any monitoring.
- Duffie, Darrell, 2009, The Failure Mechanics of Dealer Banks Journal of Economic Perspectives 24, 51–72. This is fantastic, both to
understand nuts and bolts, why there were runs, and how these markets work. If
you want to know what the "fail" in "too big to fail" means, read here. It's since grown to a book from Princeton University Press.
Reference Some of my writings on financial crisis
- "A Skeptical Appraisal of Frictions in the Financial Crisis" September 2010. Notes and Pictures. A skeptical view of the emerging consensus that the financial crisis is all about "bubbles" "liquidity spirals" "fire sales" "capital constraints" at commercial banks and so on. I do think there was a run on repo and short term financing. Good old fashioned macro asset pricing works a lot better than you might have thought.
- Asset pricing after the crash March 20 2009 This is a piece based on a panel discussion titled Rethinking asset pricing at the Spring 2009 NBER Asset Pricing meeting. It includes sceptical views on just how important credit constraints and liquidity really are. Liquidity is the frosting on the cake of finance. There is a lot of frosting these days, but still some cake.
- Lessons from the financial crisis Jan 2010 Regulation 32(4), 34-37. The financial crisis is mainly about too big to fail expectations. The only way out is to limit the government’s authority to bail out.
Week 10c Closing thoughts. Fun, and speculating about future research
Reading Suggestions (i.e. things I couldn’t stuff in to 10 weeks)
- Campbell and Cochrane,> By Force of Habit Manuscript with extra appendices The appendices document a number of calculations and answer some "what
about x?" questions. You don't have to read it but you should look quickly
to see what's here. The NBER working paper version of the paper
includes a time-varying interest rate and bond risk premia.
The JPE editor made us cut that out, but it’s not true that "Campbell-Cochrane
must have fixed interest rates."
- Campbell, John Y., and John H. Cochrane, Explaining the Poor Performance of Consumption-Based Asset
Pricing Models", Journal of Finance 55,6 (December
- Two new habit papers, to give you a sense of what people are doing with
habits these days. I'll just present the central table
- Verdelhan, Adrien, "A Habit-Based Explanation of the Exchange Rate Risk Premium"
- Stathopoulos, Andreas, 2009,Asset Prices and Risk Sharing in Open Economies"
Manuscript, USC Uses habits to increase the variance of m and solve the international
risk sharing puzzles.
A quick overview of
the other preference-based approaches to macro/asset pricing, recursive
utility, incomplete markets, multiple goods, labor income. These topics are far
more important than the short treatment I'm going to give them, but I'm leaving
the big work to Hansen and Heaton.
Dynamic Portfolio Theory.
- Cochrane, John H., Portfolio theory p. 1-15; (feel free to read 16-39, but the next reading does it
better.) p. 40-79;
- Cochrane, John H., "A Mean-Variance Benchmark for Intertemporal
Portfolio Theory" Feb 2008.
- Cochrane, John H., Manuscript for Wall Street Journal Op-Ed. Dynamic
portfolio theory matters enormously, in real-world practice. "Hedge demands" are not an abstract
curiosity. Certain big endowments that sold at the bottom in Dec 2008 should
have known better. John Campbell pointed out a grey area in my analysis. It’s
not obvious that less risk-averse people will buy assets from more risk averse people after a market crash.
- Cochrane, John, "Portfolio Advice for a Multifactor
World" Economic Perspectives Federal
Reserve Bank of Chicago 23 (3) 59-78 (1999). A popular and easy treatment that
you might enjoy as bedtime reading. Same material as the Portfolio Theory but
- Cochrane, John H. MBA Portfolio theory Notes and Slides. Always the latest summary of what's going on and what I think is important
- Cochrane, John H., Francis Longstaff and Pedro
Santa-Clara, 2008,"Two Trees: Asset
Price Dynamics Induced by Market Clearing" Review of Financial Studies 21, 347-385.
We can’t all rebalance. This paper tracks down some implications of that fact.
All wall street advice says you should constantly
- Martin, Ian, "The Lucas Orchard", Manuscript,
Stanford Univeristy (see slides too). Two trees on
- Brandt, Michael, and Pedro Santa-Clara 2006, "Dynamic Portfolio Selection by Augmenting the Asset Space"
Journal of Finance 61 2187-2218. This is a similar idea to my mean-variance
- Brandt, Michael W., Estimating Portfolio and Consumption Choice: A Conditional
Euler Equations Approach Journal of Finance 54,
1999, 1609-1646. A classic. Rather than estimate E(R) and Sigma, then optimize,
Michael estimates and maximizes at the same time, 1 = max(portoflio)
- Barberis, Nicholas, 2000,Investing for the Long Run when Returns are Predictable" , Journal of Finance, February. This and Lubos’ paper below are good
places to start when you get interested in Bayesian portfolio theory. Yes,
parameter uncertainty is real risk.
- Pastor, Lubos, "Portfolio selection and asset
pricing models" , 2000 Journal of
Finance 55, 179-223.
Liquidity, shorting, downward sloping demand
These are more general for if you get interested in the subject
- Yakov Amihud, Haim
Mendelson, and Lasse Heje Pedersen (2005), "Liquidity
and Asset Prices," Foundations and Trends in Finance, 1, 269-364. A good
survey of the literature.
- Lamont, Owen,
(2004) "Go Down Fighting: Short Sellers
vs. Firms" Manuscript, Yale University . Great
stories and some remarkable alphas showing firms with short constraints are
- Lamont, Owen, Short
Sale Constraints and Overpricing Manuscript Yale University. An
- Darrell Duffie,
Nicolae Garleanu, and Lasse Heje Pedersen (2002) "Securities
Lending, Shorting, and Pricing,", Journal of Financial Economics, 66,
307-339.A model of the "liquidity effect" explanation of short sales mispricing
- Martin D.D. Evans and Richard K. Lyons 2002, "Order Flow and Exchange Rate Dynamics" Journal of Political Economy, 110: 170-180. One of the first to correlate order flow and price
changes; the puzzle that Brandt ties up nicely. For us, the source for the
graph I'll show in class.
- Shleifer, Andrei, 1986, "Do Demand Curves for Stocks Slope Down?" The
Journal of Finance, 41, 579-590. S&P500 inclusion
gives a tiny price blip. Historically important; one of the first to show that
they do, a bit.
- Nicholas Barberis
Andrei Shleifer and Jeffrey Wurgler, 2005 "Comovement Journal of Financial Economics, 75,
283-317 This follows up on Shleifer's original, showing stocks start to move together
more when they get included in the SP500. Before you get too excited,
notice how small these effects are.
- Mitchell, Mark, Todd Pulvino and Erik Stafford, 2004, "Price Pressure Around Mergers Journal of Finance, 59, 31-63. When A tries to buy B, a lot of traders try to buy B and
short A. They claim that this lowers the price of A.
- Mitchell, Mark , Lasse Heje Pedersen, and Todd Pulvino. 2007. "Slow-Moving Capital." American Economic Review, 97(2): 215–220. DOI:10.1257/aer.97.2.215.Slides
- Pastor, Lubos, and Robert F. Stambaugh 2003, "Liquidity Risk and Expected Stock Returns" Journal of Political Economy 111,
642-685. Does cov(R, liquidity) drive expected
- Acharya, Viral V.
and Lasse H. Pedersen, 2005 "Asset pricing with liquidity
risk" Journal of Financial Economics, 77, 375-410 This one estimates the four kinds of correlation of price with liquidity. The
"theory" assumes people live two days, a convenient
but obviously, er, simplified motive for trade.
"Production based"' and investment models.
Reference: I will discuss in class some results from the
- Cochrane, John H.
Cross-Sectional Test of an Investment-Based Asset Pricing Model" Journal of Political Economy, 104 (June
- Cochrane, John H. Rethinking
Production Under Uncertainty 1993.
- Cochrane, John H. Production-Based
Asset Pricing 1988. NBER working paper 2776.
- Li., Erica X. N.,
Dmitry Livdan and Lu Zhang, 2008, Anomalies, Review of Financial Studies
22 (11), 4301-4334
- Chen, Long, and
Lu Zhang, 2010, "A Better Three-Factor Model That
Explains More Anomalies" Journal of Finance 65(2) April
- Belo, Federico,
2009, Production-Based Measures of Risk for Asset Pricing,
Forthcoming, Journal of Monetary Economics
- Jermann, Urbann,2009, "The Equity Premium
Implied by Production," Manuscript, Wharton School
I'm leaving out
here the very important topic of general equilibrium models that address the asset pricing facts (e.g. Gomes, Kogan,
Zhang; Gala; Gourio). Again, we have to stop having fun somewhere. Getting
value and growth effects out of models like these has been a big challenge. You need an interesting cross section of firms, but you don't want to carry around huge state variables .
There is a
huge amount being written on the financial crisis of course. Anil Kashyap will
teach an MBA course on it this spring, which you might take if you want to do
research on this topic. These struck me as particularly good
- Krishnamurthy, Arvind, 2008, "Fundamental Value and Limits to Arbitrage," Manuscript, Kellogg Graduate School of Management. A very nice short
documentation of two "arbitrages" from the crash. I'll show some more pictures,
including the on the run/off the run, covered interest parity, SPAC and
- Cochrane, John H, Lessons from the financial crisis Jan 2010 Regulation 32(4), 34-37. In my view, solving TBTF expectations is the
crucial policy challenge, and "regulation" with a broader TBTF guarantee isn't
going to do it.
- Cochrane, John H., Asset pricing after the crash Includes
skeptical views on just how important credit constraints and liquidity really
are. Liquidity is the frosting on the cake of finance. There is a lot of
frosting these days, but still some cake. (A response to Brunnermeier)
- Cochrane, John H., A Skeptical Appraisal of Frictions in the Financial Crisis September 2010. Notes and Pictures. This is a 2 hour lecture for Ph.D. students at the Deutsche Bank Symposium hosted by the Booth School September 2010. It offers a skeptical view of the emerging consensus that the financial crisis is all about "bubbles" "liquidity spirals" "fire sales" "capital constraints" at commercial banks and so on. I do think there was a run on repo and short term financing. Good old fashioned macro asset pricing works a lot better than you might have thought.
- Swagel, Phillip, 2009,"The finanical crisis: An
inside view" Forthcoming Brookings Papers on Economic
Activity. This is a nice view of the political and legal constraints as
well as the government's perspective. Not really asset pricing, so not on
the main list, but if you want to understand why the government did
apparently crazy things, go here.
- Baba, Naohiko
and Frank Packer, 2009, "Interpreting deviations from covered interest parity
during the financial market turmoil of 2007-2008" BIS
Working paper 267. Don't get too exited. 20 basis points is huge arbitrage, but it's still just 20 basis points.
- CDS negative basis blog post
- Fontana, Alessandro, 2009, The Persistent Negative CDS-bond basis during the 2007/08
financial crisis Manuscript, Department of Economics, Universta’ Ca’ Foscari,
Darrell, 2009, "How Should we regulate
derivatives markets?" Pew Financial reform project
Briefing Paper 5
Darrell, 2009, "Policy Issues Facing the Market for Credit Derivatives"
in The Road Ahead for the Fed, edited by John D. Ciorciari and John B. Taylor, Hoover Institution
Press, 2009. This is a short, very clear overview of the CDS issue.
- Squam Lake
Working Group, "Credit Default Swaps, Clearinghouses and Exchanges" 2009
products and repos
- Gorton, Gary, 2008, "The Subprime Panic " Manuscript,
Yale University, forthcoming European Financial Management. This has a
good summary of how subprime mortgages and complex structures actually
worked. I don't totally buy the "obscure assets" and information
story, that the ABX index forced marks to market, but it's well worth
Joshua, Jakub Jurek and Erik Stafford, The economics of structured finance,
Journal of Economic Perspectives, 23:1, 3-26. A nice piece showing how
tranches of securitized debt end up creating index options – same
probability of default, more systemic and hence higher priced risk.
- Gorton, Gary B., and Andrew
Metrick, 2009, "Securitized Banking and the Run on Repo"
Yale ICF Working Paper 09-14 Only read to p. 17.
The "run on repo" description is good, the regressions are weaker.
- Covitz, Daniel
M., Nellie Liang and Gustavo Suarez, 2009, "The Evolution of a Financial Crisis: Panic in the
Asset-Backed Commercial Paper Market" Manuscript,
Federal Reserve Board. Empirical work in the
asset-backed commercial paper market showing how ABCB is prone to "runs"
like old-fashioned bank accounts.
Arvind, 2009, "How Debt Markets Have Malfunctioned in the Crisis" Manuscript, Kellogg Graduate School of Management. Forthcoming Winter 2010 Journal
of Economic Perspectives. A simple overview of repo
and other debt markets, and some little arbitrages. I don’t buy the "spirals"
but the description is good
John H., The Monster Returns Will the silly
idea of buying up "toxic assets" not go away?
"Efficient Markets Cause the Crash," and does the crash prove behavioral
was right all along? Fama and French refute this silliness
on their blog, and Ray Ball wrote a beautiful essay, and
I have a few choice words in a longer response to Krugman's New York Times article on the crash.
Hathaway Letter From
mid 2008. This is beautifully written and I agree with almost all of it,
and illustrates Buffet’s thinking in the depth of
the crisis. Buffet’s views on writing insurance are a real high point.
Part of my "put option" writing sermon was that writing put options is a
good business, if you are transparent about the risks. Buffet is. However,
he makes a great point that municipalities are much more likely to default
if they know an insurer will lose money rather than if their own taxpayers
and voters will lose money, so that historical default probabilities are a
poor guide. The only place he gets it a little bit wrong is in the last diatribe
against the Black-Scholes formula at the
end. He forgot about "state
prices." A parachute, delivered to row 3b in the event that the back of
the plane blew up, is worth a lot more than the $1000 it costs to order on
line. Similarly, the value of any promise to pay something in the state of
the world that the S&P is lower 99 years from now than today
(essentially, the economy is back to the stone age) is worth a lot more
than probability x dollar suggests.
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