Abstract: Standard credit derivative models typically assume exogenous corporate policies and rational expectations about systematic risk. We show that subjective beliefs about disaster risk, specifically their level, not just uncertainty, drive CDX (credit default swap index) rates through endogenous corporate responses. In a consumption-based model with Epstein-Zin preferences, firms optimally choose leverage and default boundaries while learning about disaster probabilities. When disaster risk beliefs rise, the model generates a feedback effect: higher perceived risk leads to higher optimal default boundaries, decreasing distance-to-default and raising leverage, which sustains elevated credit spreads even after uncertainty resolves. Estimating on CDX data from 2003-2022, we match both the level and time-variation of investment-grade spreads and leverage ratios. The model replicates the 1-to-10 year term structure of CDX spreads in out-of-sample tests.
Discussant: Luca Benzoni, Federal Reserve Bank of Chicago
Abstract: This paper develops a new method to extract exchange rate expectations from investment positions. I use relative allocations between otherwise identical exchange-traded funds (ETFs) offered with and without a currency hedge to measure investors’ pure currency demand and infer a distribution of currency return expectations. These portfolioimplied expectations predict future exchange rates more accurately than survey-basedexpectations or expectations derived from macroeconomic models or currency pricing factors. Dispersion in portfolio-implied expectations accounts for 27% of exchange rate volatility, consistent with models of heterogeneous beliefs.
Robert Rogers, London School of Economics and Political Science
Abstract: I develop a method to extract interest-rate expectations from options markets by connecting interest-rate risk premia to interest-rate variance risk premia, with no assumptions on interest-rate stationarity. I find first that historical excess bond returns mostly reflected risk premia, not forecast errors. Second, risk-based forecasts outperform surveys and term-structure models out of sample. Third, risk-neutral variance drops sharply around FOMC announcements, suggesting a risk-premium explanation for the FOMC-announcement decline in long-term rates. Fourth, the recent positive stock-yield correlation is driven by expectations and not risk premia.
Abstract: Collecting market outlooks of asset managers, I study short-term expectations that summarize the relative risk and return attractiveness across asset classes. These tactical asset allocation views are reflected in positioning data from a survey of fund managers, in the time-series asset allocations of mutual funds, and in futures positioning. Allocation mutual funds' equity portfolio weights are two to three percentage points lower when managers' are ``underweight'' rather than ``overweight'' equities relative to their strategic asset allocations. Prompting a large-language model to infer expectations about macroeconomic fundamentals from the text-based outlooks, such a repositioning happens whenever the perceived growth outlook deteriorates.
Discussant: Federico Bastianello, London Business School
