Author
Nicolae Garleanu
Other affiliations: University of California, Berkeley, Economic Policy Institute, University of Pennsylvania
Bio: Nicolae Garleanu is an academic researcher from National Bureau of Economic Research. The author has contributed to research in topics: Capital asset pricing model & Portfolio. The author has an hindex of 18, co-authored 29 publications receiving 3564 citations. Previous affiliations of Nicolae Garleanu include University of California, Berkeley & Economic Policy Institute.
Papers
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TL;DR: In this article, the authors model the demand-pressure effect on prices when options cannot be perfectly hedged and show that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option.
Abstract: We model the demand-pressure effect on prices when options cannot be perfectly hedged The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of their unhedgeable parts Empirically, we identify aggregate positions of dealers and end users using a unique dataset, and show that demand-pressure effects contribute to well-known option-pricing puzzles Indeed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of both index options and single-stock options
588 citations
TL;DR: In this paper, the authors model the demand-pressure effect on prices when options cannot be perfectly hedged and show that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option.
Abstract: We model the demand-pressure effect on prices when options cannot be perfectly hedged. The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of their unhedgeable parts. Empirically, we identify aggregate positions of dealers and end users using a unique dataset, and show that demand-pressure effects help explain well-known option-pricing puzzles. First, end users are net long index options, especially outof-money puts, which helps explain their apparent expensiveness and the smirk. Second, demand patterns help explain the cross section of prices and skews of single-stock options.
516 citations
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TL;DR: In this article, the impact on asset prices of search-and-bargaining frictions in over-the-counter markets under certain conditions, illiquidity discounts are higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, or when risk aversion, volatility, or hedging demand are larger.
Abstract: We provide the impact on asset prices of search-and-bargaining frictions in over-the-counter markets Under certain conditions, illiquidity discounts are higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, or when risk aversion, volatility, or hedging demand are larger Supply shocks cause prices to jump, and then 'recover' over time, with a time signature that is exaggerated by search frictions We discuss a variety of empirical implications
465 citations
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TL;DR: In this paper, the optimal dynamic portfolio policy when trading is costly and security returns are predictable by signals with different mean-reversion speeds is derived in closed form, and the resulting portfolio has superior returns net of trading costs relative to more naive benchmarks.
Abstract: This paper derives in closed form the optimal dynamic portfolio policy when trading is costly and security returns are predictable by signals with different mean-reversion speeds. The optimal updated portfolio is a linear combination of the existing portfolio, the optimal portfolio absent trading costs, and the optimal portfolio based on future expected returns and transaction costs. Predictors with slower mean reversion (alpha decay) get more weight since they lead to a favorable positioning both now and in the future. We implement the optimal policy for commodity futures and show that the resulting portfolio has superior returns net of trading costs relative to more naive benchmarks. Finally, we derive natural equilibrium implications, including that demand shocks with faster mean reversion command a higher return premium.
349 citations
TL;DR: In this article, the impact of search-and-bargaining frictions on asset prices in over-the-counter markets is analyzed, showing that illiquidity discounts are higher when counterparties are harder to find, sellers have less bargaining power, when the fraction of qualified owners is smaller, or when risk aversion, volatility, or hedging demand is larger.
Abstract: We provide the impact on asset prices of search-and-bargaining frictions in over-the-counter markets. Under certain conditions, illiquidity discounts are higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, or when risk aversion, volatility, or hedging demand is larger. Supply shocks cause prices to jump, and then 'recover' over time, with a time signature that is exaggerated by search frictions: The price jump is larger and the recovery is slower in less liquid markets. We discuss a variety of empirical implications. , Oxford University Press.
320 citations
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TL;DR: In this article, the authors provide a model that links an asset's market liquidity and traders' funding liquidity, i.e., the ease with which they can obtain funding, to explain the empirically documented features that market liquidity can suddenly dry up, has commonality across securities, is related to volatility, is subject to flight to quality, and comoves with the market.
Abstract: We provide a model that links an asset's market liquidity - i.e., the ease with which it is traded - and traders' funding liquidity - i.e., the ease with which they can obtain funding. Traders provide market liquidity, and their ability to do so depends on their availability of funding. Conversely, traders' funding, i.e., their capital and the margins they are charged, depend on the assets' market liquidity. We show that, under certain conditions, margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals. The model explains the empirically documented features that market liquidity (i) can suddenly dry up, (ii) has commonality across securities, (iii) is related to volatility, (iv) is subject to “flight to quality¶, and (v) comoves with the market, and it provides new testable predictions. Keywords: Liquidity Risk Management, Liquidity, Liquidation, Systemic Risk, Leverage, Margins, Haircuts, Value-at-Risk, Counterparty Credit Risk
3,638 citations
TL;DR: In this article, the authors provide a model that links a security's market liquidity and traders' funding liquidity, i.e., their availability of funds, to explain the empirically documented features that market liquidity can suddenly dry up (i) is fragile), (ii) has commonality across securities, (iii) is related to volatility, and (iv) experiences “flight to liquidity” events.
Abstract: We provide a model that links a security’s market liquidity — i.e., the ease of trading it — and traders’ funding liquidity — i.e., their availability of funds. Traders provide market liquidity and their ability to do so depends on their funding, that is, their capital and the margins charged by their financiers. In times of crisis, reductions in market liquidity and funding liquidity are mutually reinforcing, leading to a liquidity spiral. The model explains the empirically documented features that market liquidity (i) can suddenly dry up (i.e. is fragile), (ii) has commonality across securities, (iii) is related to volatility, (iv) experiences “flight to liquidity” events, and (v) comoves with the market. Finally, the model shows how the Fed can improve current market liquidity by committing to improve funding in a potential future crisis.
3,166 citations
TL;DR: In this paper, a simple equilibrium model with liquidity risk is proposed, where a security's required return depends on its expected liquidity as well as on the covariances of its own return and liquidity with the market return.
2,020 citations
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TL;DR: This paper presented a model with leverage and margin constraints that vary across investors and time, and found evidence consistent with each of the model's five central predictions: constrained investors bid up high-beta assets, high beta is associated with low alpha, as they find empirically for U.S. equities, 20 international equity markets, Treasury bonds, corporate bonds, and futures.
Abstract: We present a model with leverage and margin constraints that vary across investors and time. We find evidence consistent with each of the model’s five central predictions: (1) Since constrained investors bid up high-beta assets, high beta is associated with low alpha, as we find empirically for U.S. equities, 20 international equity markets, Treasury bonds, corporate bonds, and futures; (2) A betting-against-beta (BAB) factor, which is long leveraged low beta assets and short high-beta assets, produces significant positive risk-adjusted returns; (3) When funding constraints tighten, the return of the BAB factor is low; (4) Increased funding liquidity risk compresses betas toward one; (5) More constrained investors hold riskier assets.
1,431 citations
TL;DR: In this article, the authors present a continuous-time equilibrium model in which overconfidence generates disagreements among agents regarding asset fundamentals, which causes a significant bubble component in asset prices even when small differences of beliefs are sufficient to generate a trade, and show that Tobin's tax can substantially reduce speculative trading when transaction costs are small, it has only a limited impact on the size of the bubble or on price volatility.
Abstract: Motivated by the behavior of asset prices, trading volume, and price volatility during episodes of asset price bubbles, we present a continuous‐time equilibrium model in which overconfidence generates disagreements among agents regarding asset fundamentals. With short‐sale constraints, an asset buyer acquires an option to sell the asset to other agents when those agents have more optimistic beliefs. As in a paper by Harrison and Kreps, agents pay prices that exceed their own valuation of future dividends because they believe that in the future they will find a buyer willing to pay even more. This causes a significant bubble component in asset prices even when small differences of beliefs are sufficient to generate a trade. In equilibrium, bubbles are accompanied by large trading volume and high price volatility. Our analysis shows that while Tobin’s tax can substantially reduce speculative trading when transaction costs are small, it has only a limited impact on the size of the bubble or on price volatility.
1,357 citations