The Journal of Finance

Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads

Published: 09/10/2008   |   DOI: 10.1111/j.1540-6261.2008.01399.x

JUN PAN, KENNETH J. SINGLETON

This paper explores the nature of default arrival and recovery implicit in the term structures of sovereign CDS spreads. We argue that term structures of spreads reveal not only the arrival rates of credit events (λℚ), but also the loss rates given credit events. Applying our framework to Mexico, Turkey, and Korea, we show that a single‐factor model with λℚ following a lognormal process captures most of the variation in the term structures of spreads. The risk premiums associated with unpredictable variation in λℚ are found to be economically significant and co‐vary importantly with several economic measures of global event risk, financial market volatility, and macroeconomic policy.

The Illiquidity of Corporate Bonds

Published: 05/23/2011   |   DOI: 10.1111/j.1540-6261.2011.01655.x

JACK BAO, JUN PAN, JIANG WANG

This paper examines the illiquidity of corporate bonds and its asset‐pricing implications. Using transactions data from 2003 to 2009, we show that the illiquidity in corporate bonds is substantial, significantly greater than what can be explained by bid–ask spreads. We establish a strong link between bond illiquidity and bond prices. In aggregate, changes in market‐level illiquidity explain a substantial part of the time variation in yield spreads of high‐rated (AAA through A) bonds, overshadowing the credit risk component. In the cross‐section, the bond‐level illiquidity measure explains individual bond yield spreads with large economic significance.

Noise as Information for Illiquidity

Published: 07/26/2013   |   DOI: 10.1111/jofi.12083

GRACE XING HU, JUN PAN, JIANG WANG

We propose a market‐wide liquidity measure by exploiting the connection between the amount of arbitrage capital in the market and observed “noise” in U.S. Treasury bonds—the shortage of arbitrage capital allows yields to deviate more freely from the curve, resulting in more noise in prices. Our noise measure captures episodes of liquidity crises of different origins across the financial market, providing information beyond existing liquidity proxies. Moreover, as a priced risk factor, it helps to explain cross‐sectional returns on hedge funds and currency carry trades, both known to be sensitive to the general liquidity conditions of the market.

Dynamic Asset Allocation with Event Risk

Published: 02/12/2003   |   DOI: 10.1111/1540-6261.00523

Jun Liu, Francis A. Longstaff, Jun Pan

Major events often trigger abrupt changes in stock prices and volatility. We study the implications of jumps in prices and volatility on investment strategies. Using the event‐risk framework of Duffie, Pan, and Singleton (2000), we provide analytical solutions to the optimal portfolio problem. Event risk dramatically affects the optimal strategy. An investor facing event risk is less willing to take leveraged or short positions. The investor acts as if some portion of his wealth may become illiquid and the optimal strategy blends both dynamic and buy‐and‐hold strategies. Jumps in prices and volatility both have important effects.

Volatility Information Trading in the Option Market

Published: 05/09/2008   |   DOI: 10.1111/j.1540-6261.2008.01352.x

SOPHIE X. NI, JUN PAN, ALLEN M. POTESHMAN

This paper investigates informed trading on stock volatility in the option market. We construct non‐market maker net demand for volatility from the trading volume of individual equity options and find that this demand is informative about the future realized volatility of underlying stocks. We also find that the impact of volatility demand on option prices is positive. More importantly, the price impact increases by 40% as informational asymmetry about stock volatility intensifies in the days leading up to earnings announcements and diminishes to its normal level soon after the volatility uncertainty is resolved.