Text-Based Linkages and Local Risk Spillovers in the Equity Market (Job Market Paper)[link]
This paper uses extensive text data to construct firms’ links via which local shocks transmit. Using the novel text-based linkages, I estimate a heterogeneous spatial-temporal model that accommodates the contemporaneous and dynamic spillover effects at the same time. I document a considerable degree of local risk spillovers in the market plus sector hierarchical factor model residuals of S&P 500 stocks. The method is found to outperform various previously studied methods in terms of out-of-sample fit. Network analysis of the spatial-temporal model identifies the major systemic risk contributors and receivers, which are of particular interest to micro-prudential policies. From a macro-prudential perspective, a rolling-window analysis reveals that the strength of local risk spillovers increases during periods of crisis, when, on the other hand, the market factor loses its importance.
A Revisit to Sovereign Risk Contagion in Eurozone with Mutual Exciting Regime-Switching Model[link]
This paper proposes a new mutual exciting regime-switching model where crises can spread contagiously across countries. Each country has its own hidden stochastic process that determines whether the country is in a normal or crisis regime. Contagion is defined as a rise in the transition probability to the crisis regime when other countries are in crisis in the past state. Using this new approach, I revisit the sovereign risk contagion in the euro area. I find that there are striking shifts in market pricing functions for the sovereign bond spreads. Multi-country contagion plays a dominant role in driving such shifts, while common risk factors and country-specific fundamentals are much less important.
A Dynamic Network of Arbitrage Characteristics (with Shaoran Li and Oliver Linton)[link] Revise and Resubmit，Journal of Business & Economic Statistics
We propose an asset pricing factor model constructed with semi-parametric characteristics-based mispricing and factor loading functions. We approximate the unknown functions by B-splines sieve where the number of B-splines coefficients is diverging. We estimate this model and test the existence of the mispricing function by a power enhanced hypothesis test. The enhanced test solves the low power problem caused by diverging B-spline coefficients, with the strengthened power approaches to one asymptotically. We also investigate the structure of mispricing components through Hierarchical K-means Clusterings. We apply our methodology to CRSP (Center for Research in Security Prices) and FRED (Federal Reserve Economic Data) data for the US stock market with one-year rolling windows during 1967-2017. This empirical study shows the presence of mispricing functions in certain time blocks. We also find that distinct clusters of the same characteristics lead to similar arbitrage returns, forming a “peer group” of arbitrage characteristics.
Augment Large Covariance Matrix Estimation with Auxiliary Network Information (with Shaoran Li, Oliver Linton, and Weiguang Liu)
Spatial Threshold Model: with an Application to Euro Area Credit Risk Contagion (with Yimeng Xie)
Generalized EGARCH Model: Factor-EGARCH (with Shaoran Li and Weiguang Liu)