Working Papers

The Macroeconomic Implications of Limited Arbitrage” (Submitted)

Previously circulated with the titles “Business Cycles and Arbitrage Cycles” and “Best Friend or Worst Enemy?”

We develop a tractable model to study the macroeconomic impacts of limited arbitrage through collateralization. Arbitrage activities and the business cycle are mutually enhancing; but their interaction can escalate unexpected shocks into arbitrage crashes and recession.  Through the interaction, we derive a micro-foundation for the endogenous, time-varying, negative borrowing rates and identify the relevant policy transmission channel. With regime shifts, we account for the non-linear aspects of crises and the slow and incomplete recoveries. Given the post-crisis regulatory reforms, we derive policy implications on liquidity provision, financial resilience and economic growth.

Available at SSRN:

Presented or Accepted for Presentation at:

  • SFS Cavalcade North America conference, May 2020, USA
  • SED 2020, Barcelona, June 2021, Spain
  • AEA-North American Winter Meeting of the Econometric Society, January 2020, San Diego, USA
  • AFA 2018 Ph.D. Poster Session, Jan 2018, Philadelphia, US
  • European Winter Meeting of the Econometric Society 2016, December 2016, Edinburgh, UK
  • The 50th Annual Conference of the Money, Macro & Finance, September 2018, Edinburgh, UK
  • EEA 2018, Aug 2018, Cologne, Germany
  • Lancaster University Management School, Feb 2018, Lancaster, UK
  • Warwick Business School, Jan 2018, Coventry, UK
  • Erasmus Management School, Jan 2018, Rotterdam, Netherlands
  • Groeningen University, Jan 2018, Groeningen, Netherlands
  • Swiss Finance Institute Research Day 2017, June 2017, Gerzensee, Switzerland
  • RES Symposium of Junior Researchers, April 2017, University of Bristol, Bristol, UK
  • Institute for Banking & Finance Brown Bag Seminar, March 2017, University of Zürich, Zürich, Switzerland

Arbitrage Run and Collateral Run” joint with Runjie Geng

We investigate the channel through which fluctuations in the market liquidity of real-sector repo collateral cause arbitrage crashes and failure of systemically important intermediaries during the global financial crisis. Intermediaries pledge productive capital as repo collateral to fund the margin for their arbitrage positions. A tiny drop in the market liquidity of capital induces higher haircuts and forces arbitrageurs to collectively unwind trading positions, resulting in adverse price movements and losses. This further reduces the collateral value of arbitrage portfolios and triggers more fire-sales in both capital and arbitrage trades. This channel creates stronger amplification effects than in Brunnermeier and Pedersen (2009), and can easily incur a simultaneous repo run and arbitrage crashes, where liquidity in several markets dry up altogether. We also show that “flight-to-liquidity” effects in intermediaries’ collateral choices after the repo run prolong the real-sector recession.

Available at SSRN:

Presented or Accepted for Presentation at:

  • European Winter Meeting of the Econometric Society 2017, December 2017, Barcelona
  • Advanced Computational Economics and Finance Seminar, December 2017, Zurich
  • Finance Department Seminar at Vrije Universiteit Amsterdam, May 2020, Amsterdam

Risky Arbitrage and Collateral Policies”

Previously circulated with the title “Amplification and Spillover Effects with Arbitrage, Production and Collateral Constraints”

We construct a dynamic model economy in which investors from segmented markets have varying financial asset demands. Intermediaries make arbitrage profits by exploiting the price spreads across markets. Meanwhile, they are required to separately post collateral to support arbitrage trades. We show that with volatile asset demands, arbitrage becomes risky. With information frictions, a looser collateral policy might render the economy more vulnerable to extremely large demand shocks, while a tighter collateral constraint helps maintain the stability at the cost of market liquidity supply.

Available at SSRN:

Presented or Accepted for Presentation at:

  • Annual Conference of the Swiss Society for Financial Market Research, March 2017, Zürich
  • Royal Economic Society Ph.D. Meetings, January 2017, London
  • Institute for Banking & Finance Brown Bag Seminar, University of Zürich, September 2016, Zürich
  • Annual Meeting of the German Sociopolicital Association 2016, August 2016, Augsburg
  • Department of Economics Brown Bag Seminar, University of Zürich, September 2016, Zürich
  • 9th World Congress of the Bachelier Finance Society, July 2016, New York (two presentations, one by co-author)
  • Midwest Macro Meetings 2016, Mai 2016, Lafayette
  • Swiss Finance Institute Research Days 2014, June 2014, Gerzensee (early version entitled “Spillover and Amplification with Financially Constrained Intermediaries”)

“Analytical Option Pricing under an Asymmetrically Displaced Double Gamma Jump-Diffusion Model”, joint with Matthias Thul

We generalize the Kou (2002) double exponential jump-diffusion model in two directions. First, we independently displace the two tails of the jump size distribution away from the origin. Second, we allow for each of the displaced tails to follow a gamma distribution with an integer-valued shape parameter. Both extensions introduce additional flexibility in the tails of the corresponding return distribution. Our model is supported by an equilibrium economy and we obtain closed-form solutions for European plain vanilla options. Our valuation function is computationally fast to evaluate and robust across the full parameter space. We estimate the physical model parameters through maximum likelihood and for a diverse sample of equities, commodities and exchange rates. For all assets under consideration, the original Kou (2002) model can be rejected in favor of our newly introduced asymmetrically displaced double gamma dynamics.

Available at SSRN:

Presented or Accepted for Presentation at:

  • University of New South Wales Brown Bag Seminar, April 2013, Sydney
  • 26th Australasian Finance & Banking Conference, December 2013, Sydney
  • Institute for Banking & Finance Brown Bag Seminar, March 2014, Zürich
  • Advances in Computational Economics and Finance, March 2014, Zürich
  • 11th German Probability and Statistics Days, March 2014, Ulm
  • Southwestern Finance Association 2014 Annual Conference, March 2014, Dallas
  • 50th Anniversary Meeting of the Eastern Finance Association, April 2014, Pittsburgh
    — The Chicago Trading Company Outstanding Paper in Derivatives Award —
  • 17th Annual Conference of the Swiss Society for Financial Market Research, April 2014, Zürich
  • 8th World Congress of the Bachelier Finance Society, June 2014, Brussels
  • 2014 FMA European Conference, June 2014, Maastricht

Recent Posts

FAQs for the AD-DG Model

In a recent working paper, cited as Thul and Zhang (2014) below, we propose a novel jump-diffusion model whose jump sizes follow an asymmetrically displaced double gamma (AD-DG) distribution. In this blog post I discuss some of the feedback that we received during seminar and conference presentations. The collection is not exhaustive and will be extended from time to time.

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  1. Stochastic Volatility with AD-DG Jumps Leave a reply