The Journal of Finance publishes leading research across all the major fields of finance. It is one of the most widely cited journals in academic finance, and in all of economics. Each of the six issues per year reaches over 8,000 academics, finance professionals, libraries, and government and financial institutions around the world. The journal is the official publication of The American Finance Association, the premier academic organization devoted to the study and promotion of knowledge about financial economics.
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Unspanned Stochastic Volatility: Evidence from Hedging Interest Rate Derivatives
Published: 01/20/2006 | DOI: 10.1111/j.1540-6261.2006.00838.x
HAITAO LI, FENG ZHAO
Most existing dynamic term structure models assume that interest rate derivatives are redundant securities and can be perfectly hedged using solely bonds. We find that the quadratic term structure models have serious difficulties in hedging caps and cap straddles, even though they capture bond yields well. Furthermore, at‐the‐money straddle hedging errors are highly correlated with cap‐implied volatilities and can explain a large fraction of hedging errors of all caps and straddles across moneyness and maturities. Our results strongly suggest the existence of systematic unspanned factors related to stochastic volatility in interest rate derivatives markets.
Interest Rate Caps “Smile” Too! But Can the LIBOR Market Models Capture the Smile?
Published: 01/11/2007 | DOI: 10.1111/j.1540-6261.2007.01209.x
ROBERT JARROW, HAITAO LI, FENG ZHAO
Using 3 years of interest rate caps price data, we provide a comprehensive documentation of volatility smiles in the caps market. To capture the volatility smiles, we develop a multifactor term structure model with stochastic volatility and jumps that yields a closed‐form formula for cap prices. We show that although a three‐factor stochastic volatility model can price at‐the‐money caps well, significant negative jumps in interest rates are needed to capture the smile. The volatility smile contains information that is not available using only at‐the‐money caps, and this information is important for understanding term structure models.
Cautious Risk Takers: Investor Preferences and Demand for Active Management
Published: 12/13/2018 | DOI: 10.1111/jofi.12747
VALERY POLKOVNICHENKO, KELSEY D. WEI, FENG ZHAO
Despite their mediocre mean performance, actively managed mutual funds are distinct from passive funds in their return distributions. Active value funds better hedge downside risk, while active growth funds better capture upside potential. Since such performance features may appeal to investors with tail‐overweighting preferences, we show that preferences for downside protection and upside potential estimated from the empirical pricing kernel can help explain active fund flows in the value and growth categories, respectively. This effect of investor risk preferences varies significantly with funds' downside‐hedging and upside‐capturing ability, with levels of active management, and across retirement and retail funds.
Neglected Risks in the Communication of Residential Mortgage‐Backed Securities Offerings
Published: 09/13/2023 | DOI: 10.1111/jofi.13278
HAROLD H. ZHANG, FENG ZHAO, XIAOFEI ZHAO
Examining the contractual disclosures during the sale of private‐label residential mortgage‐backed securities before the 2008 financial crisis, we find that textual contents in the risk‐factor section predict subsequent losses and yet were not reflected in pricing. Insurance companies, especially life insurers and insurers with low regulatory capital ratios, are more exposed to textual risks. Consistent with issuers hedging litigation risks with disclosure, we find that textual contents are associated with second‐lien underreporting and preissuance written communications. Overall, we find that investors neglected risks in the purportedly safe assets before the crisis.
Subprime Mortgage Defaults and Credit Default Swaps
Published: 10/27/2014 | DOI: 10.1111/jofi.12221
ERIC ARENTSEN, DAVID C. MAUER, BRIAN ROSENLUND, HAROLD H. ZHANG, FENG ZHAO
We offer the first empirical evidence on the adverse effect of credit default swap (CDS) coverage on subprime mortgage defaults. Using a large database of privately securitized mortgages, we find that higher defaults concentrate in mortgage pools with concurrent CDS coverage, and within these pools the loans originated after or shortly before the start of CDS coverage have an even higher delinquency rate. The results are robust across zip code and origination quarter cohorts. Overall, we show that CDS coverage helped drive higher mortgage defaults during the financial crisis.