Diminishing Treasury Convenience Premimums:

Effects of Dealers' Excess Demand In Auctions

With Suresh Sundaresan

Journal of Monetary Economics, Volume 135, April 2023, Pages 55-69

Winner of the Arthur Warga Award 2019 (previous title: How Safe are Safe Havens?)


Abstract: After the global financial crisis, the yields of U.S. Treasury bills frequently exceed other risk-free rate benchmarks, thereby pointing to a diminishing convenience premium. Constructing a new measure of dealers' balance sheet constraints for providing intermediation in U.S. Treasury markets, we trace these diminishing convenience premiums to primary dealers' ability to act as intermediaries. Even after accounting for Treasury supply, levels of interest rates, and other controls, falling excess demand of primary dealers in Treasury auctions, their increased Treasury holdings, and balance sheet constraints post-2015, remain key variables in explaining the diminishing convenience premiums.


High Funding Risk and Low Hedge Fund Returns

Previous title: High Funding Risk, Low Return

Critical Finance Review, Volume 11, issues 3-4

Abstract: I show that hedge funds with a high exposure to market-wide funding shocks - measured by changes in LIBOR-OIS spreads - subsequently underperform funds with a low exposure to market-wide funding shocks by 5.76% annually on a risk-adjusted basis (t=4.04). To explain this puzzling result, I hypothesize that this type of funding risk exposure is connected to hedge funds' liabilities with limited upside in normal times and severe downside risk during funding crises. Supporting this hypothesis, the performance difference between low-funding-risk and high-funding-risk funds is largest when funding constraints are most binding and for funds with more fragile liabilities.

Life After LIBOR

with Olav Syrstad

Journal of Financial Economics, Volume 141 (2), pages 783-801

Short summary for the SOFR academy

A previous version ("Burying LIBOR") was circulated as Norges Bank Working Paper


Abstract: We examine the alternative reference rates that are set to replace the London Interbank Offered Rate (LIBOR) as benchmark rate by the end of 2021. After providing the relevant background, we show that: (i) depending on the marginal lenders, tighter regulatory constraints can either increase or decrease the alternative benchmarks; (ii) increases in the amount of government debt outstanding increase the alternative benchmarks, more so for collateralized rates; (iii) more central bank reserves lower the alternative benchmarks. In addition, we show that term rates based on the alternative reference rates are detached from banks' marginal funding costs.

Active Loan Trading

with Frank Fabozzi, Pia Mølgaard, Mads Stenbo Nielsen

Journal of Financial Intermediation, Volume 46 (2021), article 100868


Abstract: Using a novel dataset of leveraged loan trades executed by managers of collateralized loan obligations (CLOs), we document the importance of "active loan trades" - trades executed at a manager's discretion. More active trading increases the returns to CLO equity investors, lowers collateral portfolio default rates, and increases the manager's chances of closing a new deal. Examining the observed loan trades, we find that more active CLOs trade at better prices than less active CLOs, selling leveraged loans earlier and before they get downgraded. Our findings suggest that more active CLOs are better at anticipating deteriorations in loan credit quality.

An Explanation of Negative Swap Spreads:

Demand for Duration from Underfunded Pension Plans

with Suresh Sundaresan
Journal of Finance, Volume 72 (2) (2019), pages 675-710

Winner of the SFI outstanding paper award 2016


Abstract: The 30-year U.S. swap spreads have been negative since September 2008. We offer a novel explanation for this persistent anomaly. Through an illustrative model, we show that underfunded pension plans optimally use swaps for duration hedging. Combined with dealer banks' balance sheet constraints, this demand can drive swap spreads to become negative. Empirically, we construct a measure of the aggregate funding status of Defined Benefit pension plans and show that this measure is a significant explanatory variable of 30-year swap spreads. We find a similar link between pension funds' underfunding and swap spreads for two other regions.

Safe Haven CDS Premiums

with David Lando

Review of Financial Studies, Volume 31 (5) (2018), pages 1856-1895


Abstract: We develop a model in which a derivatives-dealing bank faces capital charges from uncollateralized swap positions with sovereigns, and buys Credit Default Swap (CDS) contracts to obtain capital relief. CDS premiums depend on margin requirements for buyers and sellers of CDS contracts, the value of capital relief for the dealer banks, and the return on a risky asset. We explain the regulatory requirements that lead derivatives dealers to buy CDS and translate volumes of derivatives contracts outstanding between sovereigns and banks into CDS hedging demand. We argue that CDS premiums for safe sovereigns are primarily driven by regulatory requirements.

Article based on my master thesis:

Option Pricing with Time-Changed Levy Processes

with Y. S. Kim, S. T. Rachev, and F. J. Fabozzi

Applied Financial Economics, 2013, 23(15) p. 1231-1238


Abstract: In this article, we introduce two new six-parameter processes based on time-changing tempered stable distributions and develop an option pricing model based on these processes. This model provides a good fit to observed option prices. To demonstrate the advantages of the new processes, we conduct two empirical studies to compare their performance to other processes that have been used in the literature.

Working Papers

Taking advantage of media attention to climate change: CLOs‘ trading of brown loans

With Kathrin Hackenberg, Viktoria Klaus, and Talina Sondershaus (January 12, 2024)


Abstract: Collateralized Loan Obligations (CLOs) are the main investors in leveraged loans, and we show in this paper that they take advantage of heightened media attention to climate change. Utilizing transaction data on leveraged loans, we find loans of firms in carbon-intensive industries trade at a discount when media attention to climate change is elevated. CLOs take advantage of these price discounts by tilting their portfolios toward carbon-intensive industries. This portfolio tilting is still present for CLO managers who signed the principles of responsible investing (PRI) and thereby committed to considering environmental factors in their investments. Hence, CLOs are one investor class purchasing from institutional investors who divest from brown industries.

Pension Liquidity Risk

With Kristy Jansen, Angelo Ranaldo, and Patty Duijm (June 25, 2023)


Abstract: Pension funds are increasingly relying on swaps to hedge the long-term nature of their liabilities. While the use of swaps reduces pension funds' exposure to interest rate risk, it exposes pension funds to liquidity risk because of potential margin calls. We study these effects using unique data for the Dutch pension system and show that hedging behavior exposes pension funds to margin call risk that can be as large as 7-19% of total assets under management. When interest rates hike and this risk materializes, pension funds liquidate parts of their fixed income portfolios, primarily selling safe government bonds. This procyclical selling behavior has an adverse impact on bond prices.

Does SOFR-Linked Debt Cost Borrowers More Than LIBOR-Linked Debt?

With Olav Syrstad (May 22, 2023)


Abstract: The transition from London Interbank Offered Rate (LIBOR) to Secured Overnight Financing Rate (SOFR) affects the reference rate of floating-rate debt worth trillions of dollars. Focusing on the primary market for dollar-denominated floating rate notes (FRNs), we compare the yield spreads of FRNs linked to LIBOR and SOFR, issued by the same entity during the same month. After adjusting for the maturity-matched spread expectations from derivatives markets, we find significantly lower spreads for SOFR-linked FRNs. A qualitatively similar pattern emerges for syndicated loans, despite identification challenges. Hence, concerns that the benchmark transition resulted in higher borrowing costs are unwarranted. 

Corporate Pension Risk Transfers

With Suresh Sundaresan and Michael Moran (New Version: December 20, 2022)


Abstract: Between 2012 and 2022, U.S. corporate sponsors of defined benefit (DB) pension plans used pension risk transfers (PRTs) to transfer more than $150 billion pension obligations to insurance companies, thereby reducing the pool of corporate DB plan participants by 10%. We assemble a new PRT database and study the drivers and consequences of PRTs. Consistent with a simple model, the propensity to conduct a PRT is higher for firms with higher flow-through costs from their pension plans and higher burdens for paying insurance premiums to the Pension Benefit Guarantee Corporation (PBGC). Safer plan sponsors with less default risk and less volatility in their pension assets are more likely to conduct PRTs thereby increasing PBGC's pool risk.


Disclosing the Undisclosed: Commercial Paper as Hidden Liquidity Buffers

With Olav Syrstad - New version (December 20, 2022)

This paper subsumes our old working paper "Cash is Not King: Evidence from the Commercial Paper Market"


Abstract: Using new transaction-level data for non-financial commercial paper (CP) in the U.S., we show that companies systematically reduce their outstanding short-term debt on quarterly and annual disclosure dates. Constraints on CP lending supply cannot explain this pattern. Instead, companies optimize their disclosed liquidity buffers and strategically repay CP debt if doing so strengthens common accounting ratios, such as the current ratio. Unlike other CP issuers, firms that repay their CP debt neither hold lower cash buffers nor use CP as bridge financing, suggesting an alternative role of CP debt as “hidden liquidity buffer”.


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