Publications

Volatility, Valuation Ratios and Bubbles: An Empirical Measure of Market Sentiment, with Ian Martin, Journal of Finance (2021), 76:6:3211‒3254. 

• Slides. 

• Sentiment Indicator Data (US Market, 1996-2019).

• See the top of this page for a dynamic chart, updated occasionally.

• UK application: Bank of England underground post.

• Abstract: We define a sentiment indicator based on option prices, valuation ratios, and interest rates. The indicator can be interpreted as a lower bound on the expected growth in fundamentals that a rational investor would have to perceive to be happy to hold the market. The bound was unusually high in the late 1990s, reflecting dividend growth expectations that in our view were unreasonably optimistic. Our approach exploits two key ingredients. First, we derive a new valuation ratio decomposition that is related to the Campbell and Shiller loglinearization but that resembles the Gordon growth model more closely and has certain other advantages. Second, we introduce a volatility index that provides a lower bound on the market’s expected log return.

• Sveriges Riksbank, Fed NY, ECB, BoE, NBER Behavioral Finance 2019. CICF 2019, Econometric Society Asian 2019, FRIC 2019 (by CBS), Duke, LSE.

Working Papers

Debt and Deficits: Fiscal Analysis with Stationary Ratios, with John Campbell and Ian Martin.

• Slides (from site of Ian Martin).

• Abstract: We introduce a new measure of a government’s fiscal position that exploits cointegrating relationships among fiscal variables and output. The measure is a loglinear combination of tax revenue, government spending and the market value of government debt that—unlike the debt-GDP ratio—is stationary in the US and the UK since World War II. Fiscal deterioration forecasts a long-run decline in spending rather than increased tax revenue or low returns for bondholders. Fiscal adjustment to tax and spending shocks occurs through mean-reversion in tax and spending growth, with a negligible contribution from debt returns. 

• NBER Summer Institute 2023 (Asset Pricing), CBS, U of Washington, LSE, Harvard, Fulcrum Asset Management, HKUST-GZ.

Survey Expectations Meet Option Prices: New Insights from the FX Markets, with Pasquale Della Corte and Alexandre Jeanneret.

• Supported by Canandian Derivative Institute.

• Earlier version circulated under the title: Expected currency returns and term structure of risk preferences.

• Abstract: We reconcile two sources of forward-looking expectations for currency returns: consensus forecasts from major financial intermediaries and over-the-counter currency option prices. To connect these expectations, we adopt a broad framework based on no-arbitrage conditions and motivated by various benchmark asset pricing models. Using more than twenty years of data on a large cross-section of currency pairs with maturities of up to two years,  we find that the average value of general risk preferences is between 3 and 4. The general risk preferences, moreover, display an upward-sloping term structure in `good times' and a downward-sloping term structure during `bad times'.

• Swiss Finance Institute Research Day 2024, CUHK-RAPS Conference 2023, Bank of Canada, HKU, ICEEE 2023, QRFE Asset Pricing Workshop (Durham U) 2023, U of Laval, HEC Montreal, Fulcrum Asset Management, VSFX 2022, Doctoral Consortium of the Asian Finance Association 2022, LIF-SAFE Frankfurt, HSG, UNSW. 

Understanding the Predictive Variance of Long-Term Bonds, with Pasquale Della Corte, Deniel P.A. Preve and Giorgio Valente.

• Abstract: We study the long-horizon risk profile of a currency strategy, whereby a US investor earns excess returns by entering in an unhedged long position in a foreign long-term bond funded at the domestic risk-free rate. After showing the drivers of the strategy returns, we derive and estimate their long-horizon predictive variance using data on long-term bonds denominated in major currencies over the past two centuries. We find that the long-horizon risk of such strategies increases with the investment horizon and that it is mainly driven by the uncertainty associated with the predictions of future returns originating from interest rate differentials and exchange rate returns.

• ABFER 2022; BoE; Workshop on Bayesians in Finance, Singapore 2018; Belgrade Symposium in Economics and Finance 2018. 

Heterogeneous Beliefs on N Tree, with Brandon Yueyang Han.

• Abstract: We solve a discrete time multi-nomial tree model featuring risk-averse agents with heterogeneous beliefs on higher-order moments of the fundamental news. The model is a natural extension of Martin and Papadimitriou (2022). The disagreement on higher order moments makes agents' trading decisions, equilibrium asset prices, and the aggregate sentiment path-dependent, which provide rich implications.

• EPFL

Betting Against Correlations: A Measure of Global Market Risk, with Paul Schneider.

• Abstract: We measure the systemic risk of FX exchange rates by relating the joint distribution of exchange rates to a distribution that assumes independence. A sharp upper bound of the distance between those two can be constructed through a quadratic portfolio problem where the representative agent bets against correlations among exchange rates. Using forward-looking information from the cross-section of option prices and consensus forecasts, we can compute the systemic foreign exchange risk in real-time, and investigate it in a broader macroeconomic context.

• Cancun Derivative Workshop 2022, Swiss Finance Institute Research Day 2022.