The Journal of Finance

Do Prices Reveal the Presence of Informed Trading?

Published: 03/09/2015   |   DOI: 10.1111/jofi.12260

PIERRE COLLIN‐DUFRESNE, VYACHESLAV FOS

Using a comprehensive sample of trades from Schedule 13D filings by activist investors, we study how measures of adverse selection respond to informed trading. We find that on days when activists accumulate shares, measures of adverse selection and of stock illiquidity are lower, even though prices are positively impacted. Two channels help explain this phenomenon: (1) activists select times of higher liquidity when they trade, and (2) activists use limit orders. We conclude that, when informed traders can select when and how to trade, standard measures of adverse selection may fail to capture the presence of informed trading.

On the Term Structure of Default Premia in the Swap and LIBOR Markets

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00357

Pierre Collin‐Dufresne, Bruno Solnik

Existing theories of the term structure of swap rates provide an analysis of the Treasury–swap spread based on either a liquidity convenience yield in the Treasury market, or default risk in the swap market. Although these models do not focus on the relation between corporate yields and swap rates (the LIBOR–swap spread), they imply that the term structure of corporate yields and swap rates should be identical. As documented previously (e.g., in Sun, Sundaresan, and Wang (1993)) this is counterfactual. Here, we propose a model of the default risk imbedded in the swap term structure that is able to explain the LIBOR–swap spread. Whereas corporate bonds carry default risk, we argue that swap contracts are free of default risk. Because swaps are indexed on “refreshed”‐credit‐quality LIBOR rates, the spread between corporate yields and swap rates should capture the market's expectations of the probability of deterioration in credit quality of a corporate bond issuer. We model this feature and use our model to estimate the likelihood of future deterioration in credit quality from the LIBOR–swap spread. The analysis is important because it shows that the term structure of swap rates does not reflect the borrowing cost of a standard LIBOR credit quality issuer. It also has implications for modeling the dynamics of the swap term structure.

Liquidity, Volume, and Order Imbalance Volatility

Published: 05/24/2023   |   DOI: 10.1111/jofi.13248

VINCENT BOGOUSSLAVSKY, PIERRE COLLIN‐DUFRESNE

We examine the dynamics of liquidity using a comprehensive sample of U.S. stocks in the post‐decimalization period. Motivated by a continuous‐time inventory model, we compute a high‐frequency measure of order imbalance volatility to proxy for the inventory risk faced by liquidity providers. We show that high‐frequency order imbalance volatility is an important driver of liquidity and explains the often positive time‐series relation between spread and volume for large stocks, which seems to run counter to most theoretical models. Furthermore, order imbalance volatility is priced in the cross‐section of stock returns.

Stochastic Convenience Yield Implied from Commodity Futures and Interest Rates

Published: 09/16/2005   |   DOI: 10.1111/j.1540-6261.2005.00799.x

JAIME CASASSUS, PIERRE COLLIN‐DUFRESNE

We characterize a three‐factor model of commodity spot prices, convenience yields, and interest rates, which nests many existing specifications. The model allows convenience yields to depend on spot prices and interest rates. It also allows for time‐varying risk premia. Both may induce mean reversion in spot prices, albeit with very different economic implications. Empirical results show strong evidence for spot‐price level dependence in convenience yields for crude oil and copper, which implies mean reversion in prices under the risk‐neutral measure. Silver, gold, and copper exhibit time variation in risk premia that implies mean reversion of prices under the physical measure.

Do Credit Spreads Reflect Stationary Leverage Ratios?

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00395

Pierre Collin‐Dufresne, Robert S. Goldstein

Most structural models of default preclude the firm from altering its capital structure. In practice, firms adjust outstanding debt levels in response to changes in firm value, thus generating mean‐reverting leverage ratios. We propose a structural model of default with stochastic interest rates that captures this mean reversion. Our model generates credit spreads that are larger for low‐leverage firms, and less sensitive to changes in firm value, both of which are more consistent with empirical findings than predictions of extant models. Further, the term structure of credit spreads can be upward sloping for speculative‐grade debt, consistent with recent empirical findings.

Do Bonds Span the Fixed Income Markets? Theory and Evidence for Unspanned Stochastic Volatility

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00475

Pierre Collin‐Dufresne, Robert S. Goldstein

Most term structure models assume bond markets are complete, that is, that all fixed income derivatives can be perfectly replicated using solely bonds. How ever, we find that, in practice, swap rates have limited explanatory power for returns on at‐the‐money straddles—portfolios mainly exposed to volatility risk. We term this empirical feature unspanned stochastic volatility (USV). While USV can be captured within an HJM framework, we demonstrate that bivariate models cannot exhibit USV. We determine necessary and sufficient conditions for trivariate Markov affine systems to exhibit USV. For such USV models, bonds alone may not be sufficient to identify all parameters. Rather, derivatives are needed.

On the Relative Pricing of Long‐Maturity Index Options and Collateralized Debt Obligations

Published: 11/19/2012   |   DOI: 10.1111/j.1540-6261.2012.01779.x

PIERRE COLLIN‐DUFRESNE, ROBERT S. GOLDSTEIN, FAN YANG

We investigate a structural model of market and firm‐level dynamics in order to jointly price long‐dated S&P 500 index options and CDO tranches of corporate debt. We identify market dynamics from index option prices and idiosyncratic dynamics from the term structure of credit spreads. We find that all tranches can be well priced out‐of‐sample before the crisis. During the crisis, however, our model can capture senior tranche prices only if we allow for the possibility of a catastrophic jump. Thus, senior tranches are nonredundant assets that provide a unique window into the pricing of catastrophic risk.

Dividend Dynamics and the Term Structure of Dividend Strips

Published: 01/27/2015   |   DOI: 10.1111/jofi.12242

FREDERICO BELO, PIERRE COLLIN‐DUFRESNE, ROBERT S. GOLDSTEIN

Many leading asset pricing models are specified so that the term structure of dividend volatility is either flat or upward sloping. These models predict that the term structures of expected returns and volatilities on dividend strips (i.e., claims to dividends paid over a prespecified interval) are also upward sloping. However, the empirical evidence suggests otherwise. This discrepancy can be reconciled if these models replace their proposed dividend dynamics with processes that generate stationary leverage ratios. Under such policies, shareholders are forced to divest (invest) when leverage is low (high), which shifts risk from long‐ to short‐horizon dividend strips.

Market Structure and Transaction Costs of Index CDSs

Published: 06/01/2020   |   DOI: 10.1111/jofi.12953

PIERRE COLLIN‐DUFRESNE, BENJAMIN JUNGE, ANDERS B. TROLLE

Despite regulatory efforts to promote all‐to‐all trading, the post–Dodd‐Frank index credit default swap market remains two‐tiered. Transaction costs are higher for dealer‐to‐client than interdealer trades, but the difference is explained by the higher, largely permanent, price impact of client trades. Most interdealer trades are liquidity motivated and executed via low‐cost, low‐immediacy trading protocols. Dealer‐to‐client trades are nonanonymous; they almost always improve upon contemporaneous executable interdealer quotes, and dealers appear to price discriminate based on the perceived price impact of trades. Our results suggest that the market structure is a consequence of the characteristics of client trades: relatively infrequent, large, and differentially informed.

Portfolio Choice over the Life‐Cycle when the Stock and Labor Markets Are Cointegrated

Published: 09/04/2007   |   DOI: 10.1111/j.1540-6261.2007.01271.x

LUCA BENZONI, PIERRE COLLIN‐DUFRESNE, ROBERT S. GOLDSTEIN

We study portfolio choice when labor income and dividends are cointegrated. Economically plausible calibrations suggest young investors should take substantial short positions in the stock market. Because of cointegration the young agent's human capital effectively becomes “stock‐like.” However, for older agents with shorter times‐to‐retirement, cointegration does not have sufficient time to act, and thus their human capital becomes more “bond‐like.” Together, these effects create hump‐shaped life‐cycle portfolio holdings, consistent with empirical observation. These results hold even when asset return predictability is accounted for.

How Integrated are Credit and Equity Markets? Evidence from Index Options

Published: 12/12/2023   |   DOI: 10.1111/jofi.13300

PIERRE COLLIN‐DUFRESNE, BENJAMIN JUNGE, ANDERS B. TROLLE

We study the extent to which credit index (CDX) options are priced consistent with S&P 500 (SPX) equity index options. We derive analytical expressions for CDX and SPX options within a structural credit‐risk model with stochastic volatility and jumps using new results for pricing compound options via multivariate affine transform analysis. The model captures many aspects of the joint dynamics of CDX and SPX options. However, it cannot reconcile the relative levels of option prices, suggesting that credit and equity markets are not fully integrated. A strategy of selling CDX volatility yields significantly higher excess returns than selling SPX volatility.

Identification of Maximal Affine Term Structure Models

Published: 04/01/2008   |   DOI: 10.1111/j.1540-6261.2008.01331.x

PIERRE COLLIN‐DUFRESNE, ROBERT S. GOLDSTEIN, CHRISTOPHER S. JONES

Building on Duffie and Kan (1996), we propose a new representation of affine models in which the state vector comprises infinitesimal maturity yields and their quadratic covariations. Because these variables possess unambiguous economic interpretations, they generate a representation that is globally identifiable. Further, this representation has more identifiable parameters than the “maximal” model of Dai and Singleton (2000). We implement this new representation for select three‐factor models and find that model‐independent estimates for the state vector can be estimated directly from yield curve data, which present advantages for the estimation and interpretation of multifactor models.