Jens Hilscher

Are Credit Default Swaps a Sideshow? Evidence that Information Flows from Equity to CDS Markets

This paper provides evidence that equity returns lead credit protection returns at daily and weekly frequencies, while credit protection returns do not lead equity returns. Our results indicate that informed traders are primarily active in the equity rather than the CDS market. These findings are consistent with standard theories of market selection by informed traders in which market selection is determined partially by transaction costs. We also find that credit protection returns respond more quickly during salient news events (earnings announcements) compared to days with similar equity returns and turnover. This evidence provides support for explanations related to investor inattention.

Sources of Momentum Profits: Evidence on the Irrelevance of Characteristics

Several recent studies document that sorting stocks first on certain stock-level characteristics and then on past returns results in elevated momentum profits. We show that such strategies enhance momentum profits simply by trading in stocks with more extreme past returns. Adjusted for this effect, elevated momentum profits resulting from characteristics (size, R², turnover, age, analyst coverage, analyst forecast dispersion, market-to-book, price, illiquidity, credit rating) disappear almost entirely. Interaction patterns have been used to support behavioral and limits-to-arbitrage explanations of momentum; our findings imply that explanations of momentum should instead focus on the link between momentum profits and extreme past returns.

Inflating Away the Public Debt? An Empirical Assessment

We propose and implement a method that provides quantitative estimates of the extent to which higher-than-expected inflation can lower the real value of outstanding government debt. Looking forward, we derive a formula for the debt burden that relies on detailed information about debt maturity and claimholders, and that uses option prices to construct risk-adjusted probability distributions for inflation at different horizons. The estimates suggest that it is unlikely that inflation will lower the US fiscal burden significantly, and that the effect of higher inflation is modest for plausible counterfactuals. If instead inflation is combined with financial repression that ex post extends the maturity of the debt, then the reduction in value can be significant.

Optimal Regulation, Executive Compensation and Risk Taking by Financial Institutions

We present an equilibrium model of financial institutions in which we examine the optimal regulation of risk taking. Choice of risk levels result from strategic interactions of regulators, shareholders, and management. Regulators use caps on asset risk and equity-based compensation to achieve the optimal level of risk; shareholders choose levels of managements stock ownership; and management chooses asset risk. We characterize the socially optimal level of risk. If there is perfect information and enforcement, using one policy tool is sufficient. If enforcement is limited or information is asymmetric, there can be gains to social welfare from employing both policy tools.

Inflation Derivatives Under Inflation Target Regimes

Inflation targeting -- the central bank practice of attempting to keep inflation levels within fixed bounds around a quantitative target -- has been adopted by more than twenty economies. Such practice has an important impact on the stochastic nature of inflation and, consequently, on the pricing of inflation derivatives. We develop a flexible model of inflation targeting in which the central banks intervention to steer inflation towards the target depends on past deviations and the policymakers ability or will to enforce the target. We use our model to price inflation derivatives and demonstrate the impact of inflation targeting on derivative pricing.