Intermediaries and Asset Returns
Friday, Jan. 3, 2020 2:30 PM - 4:30 PM (PDT)
- Chair: Dimitris Papanikolaou, Northwestern University
Are Intermediary Constraints Priced?
AbstractViolations of no-arbitrage conditions measure the shadow cost of constraints on intermediaries, and the risk that these constraints tighten is priced. We demonstrate in an intermediary-based asset pricing model that violations of no-arbitrage such as covered interest rate parity (CIP) violations, along with intermediary wealth returns, can be used to price assets. We describe a “forward CIP trading strategy” that bets on CIP violations becoming smaller, and show that its returns help identify the price of the risk that the shadow cost of intermediary constraints increases. This risk contributes substantially to the volatility of the stochastic discount factor, and appears to be priced consistently in U.S. treasury, emerging market sovereign bond, and foreign exchange portfolios.
Interest Arbitrage under Capital Controls: Evidence from Reported Entrepôt Trades
AbstractCapital controls segment the offshore credit market of Chinese renminbi from the onshore one. Using a novel administrative data set, we provide evidence that firms arbitrage the onshore-offshore interest differentials using bank-intermediated "entrepôt trades," which supposedly re-export imports with little or no processing. Onshore-offshore interest differentials drive renminbi's inflows from "entrepôt trades," which strongly predict one-year forward outflows settling bank-issued Letters of Credit. Interest differentials have greater impacts on the lower half of the outflows distribution and induce entries to "entrepôt trades." Our findings suggest that renminbi interest arbitrages are feasible but costly under capital controls.
- G1 - General Financial Markets