Darrell Duffie

Darrell Duffie
Stanford University | SU · Graduate School of Business

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240
Publications
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36,996
Citations

Publications

Publications (240)
Article
Corporate credit lines are drawn more heavily when funding markets are stressed. This elevates expected bank funding costs. We show that credit supply is dampened by the associated debt‐overhang cost to bank shareholders. Until 2022, this impact was reduced by linking the interest paid on lines to a credit‐sensitive reference rate like the London i...
Article
We show that the likelihood of a liquidity crunch in wholesale US dollar funding markets depends on levels of reserve balances at the financial institutions that are the most active intermediaries of these markets. Heightened risk of an imminent liquidity crunch is signaled by significant delays in intra-day payments to these large financial instit...
Article
We design a novel across‐the‐curve credit spread index, AXI, a measure of the recent cost of wholesale unsecured debt funding for publicly listed US bank holding companies and commercial banks. AXI, a benchmark for bank lending and risk management, is the weighted average of credit spreads for unsecured debt instruments with maturities ranging from...
Article
We model the design of a benchmark fixing as an estimator of fair market value. The fixing data are the transactions of agents whose profits depend on the fixing, implying incentives for manipulation. We derive the optimal linear fixing under an assumption that transaction weights are unidimensional. We also axiomatically characterize the unique li...
Article
The financial crisis that began in 2007 was triggered by over-leveraged homeowners and a severe downturn in US housing markets. However, a reasonably well-supervised financial system would have been much more resilient to this and other types of severe shocks. Instead, the core of the financial system became a key channel of propagation and magnifi...
Article
In this paper, we demonstrate that the funding value adjustments (FVAs) of major dealers are debt overhang costs to their shareholders. To maximize shareholder value, dealer quotations therefore adjust for FVAs. Our case studies include interest‐rate swap FVAs and violations of covered interest parity. Contrary to current valuation practice, FVAs a...
Article
We measure credit risk premia-prices for bearing corporate default risk in excess of expected default losses-using Markit CDS and Moody's Analytics EDF data. We find dramatic variation over time in credit risk premia, with peaks in 2002, during the global financial crisis of 2008-09, and in the second half of 2011. Even after normalizing these prem...
Article
Full-text available
Libor is a survey-based measure of bank borrowing costs that plays a central role in fixed-income markets. There is an active discussion about how well Libor summarized funding conditions during the recent financial crisis. In this paper we match and compare bank Libor survey responses to two novel measures of borrowing rates: 1) bank bids at the F...
Article
We develop a general and unified model in which a continuum of agents conduct directed random searches for counterparties. Our results provide the first probabilistic foundation for static and dynamic models of directed search (including the matching-function approach) that are common in search-based models of financial markets, monetary theory, an...
Article
This is a survey of progress with the postcrisis global (G20) reform of the financial system, in five key areas of new regulation: (1) making financial institutions more resilient; (2) ending “too-big-to-fail”; (3) making derivatives markets safer; (4) transforming shadow banking; and (5) improving trade competition and market transparency. The res...
Article
We characterize the role of benchmarks in price transparency of over-the-counter markets. A benchmark can raise social surplus by increasing the volume of beneficial trade, facilitating more efficient matching between dealers and customers, and reducing search costs. Although the market transparency promoted by benchmarks reduces dealers' profit ma...
Article
Size-discovery mechanisms allow large quantities of an asset to be exchanged at a price that does not respond to price pressure. Primary examples include “workup” in Treasury markets, “matching sessions” in corporate bond and CDS markets, and block-trading “dark pools” in equity markets. By freezing the execution price and giving up on market-clear...
Article
LIBOR is the London Interbank Offered Rate: a measure of the interest rate at which large banks can borrow from one another on an unsecured basis. LIBOR is often used as a benchmark rate—meaning that the interest rates that consumers and businesses pay on trillions of dollars in loans adjust up and down contractually based on movements in LIBOR. In...
Article
We study equilibria of dynamic over-the-counter markets in which agents are distinguished by their preferences and information. Over time, agents are privately informed by bids and offers. Investors differ with respect to information quality, including initial information precision, and also in terms of market "connectivity," the expected frequency...
Article
Size-discovery mechanisms allow large quantities of an asset to be exchanged at a price that does not respond to price pressure. Primary examples include "workup" in Treasury markets, "matching sessions" in corporate bond and CDS markets, and block-trading "dark pools" in equity markets. By freezing the execution price and giving up on market clear...
Article
Full-text available
We propose a structural model of a takeover auction that allows for asym-metries between strategic and financial bidders. Using a hand-collected data on the number of competing bidders, their types and bids, we esti-mate the model to recover valuations (i.e. maximum willingness to pay) of participating strategic and financial bidders. The results s...
Article
This paper discusses some of the challenges faced by a policy treatment of speculative trading that is motivated by differences in beliefs. The first challenge is philosophical. Suppose two investors prefer to speculate with each other, under the common knowledge that they are motivated to trade purely by a difference in beliefs (unconditional prob...
Article
We use an extensive data set of bilateral exposures on credit default swap (CDS) to estimate the impact on collateral demand of new margin and clearing practices and regulations. We decompose collateral demand for both customers and dealers into several key components, including the “velocity drag” associated with variation margin movements. We dem...
Article
We characterize the price-transparency role of benchmarks in over-the-counter markets. A benchmark can, under conditions, raise social surplus by increasing the volume of beneficial trade, facilitating more efficient matching between dealers and customers, and reducing search costs. Although the market transparency promoted by benchmarks reduces de...
Article
LIBOR is the London Interbank Offered Rate: a measure of the interest rate at which large banks can borrow from one another on an unsecured basis. LIBOR is often used as a benchmark rate—meaning that the interest rates that consumers and businesses pay on trillions of dollars in loans adjust up and down contractually based on movements in LIBOR. In...
Article
To address the moral hazard problem that can motivate bank executives to take excessive risks and to fail to raise capital when needed, a group of 13 distinguished financial economists recommends that systemically important financial institutions be required to issue contingent convertible debt (CoCos) and to hold back a substantial share—as much a...
Article
UBS recently announced it would pay part of the bonuses of 6,500 highly compensated employees with bonds that would be forfeited if the bank does not meet its capital requirements. This memo underscores the benefits of contingent deferred compensation and makes recommendations for how such compensation should be structured at systemically important...
Article
We examine the properties of a method for fixing Libor rates that is based on transactions data and multi-day sampling windows. The use of a sampling window may mitigate problems caused by thin transaction volumes in unsecured wholesale term funding markets. Using two partial data sets of loan transactions, we estimate how the use of different samp...
Article
The financial crisis of 2007-09 has spurred significant ongoing changes in the "pipes and valves" through which cash and risk flow through the center of our financial system. These include adjustments to the forms of lender-of-last-resort financing from the central bank and changes the infrastructure for the wholesale overnight financing of major d...
Article
We calculate equilibria of dynamic over-the-counter markets in which agents are distinguished by their preferences and information. Over time, agents are privately informed by bids and offers. Investors differ with respect to information quality, including initial information precision as well as market "connectivity," the expected frequency of the...
Article
We propose a redesign of sovereign Credit Default Swaps (CDS). Under our proposal, a notional CDS position of €100 can be settled by the delivery of whatever package of instruments a sovereign gives in exchange for legacy bonds with a face value of €100. To illustrate, suppose a European sovereign restructures its debt by forcibly exchanging each €...
Article
For nearly two years, the two of us have had a running discussion of the costs and benefits of automatic stays in bankruptcy for qualified financial contracts (QFCs) such as derivatives and repurchase agreements, particularly those held by systemically important major dealer banks. Under current U.S. bankruptcy law, these contracts are exempted fro...
Article
This submission discusses implications for the quality and safety of financial markets of proposed rules implementing the market-making provisions of section 13 of the Bank Holding Company Act, commonly known as the “Volcker Rule.” The proposed rules1 have been described by the Office of the Comptroller of the Currency, the Board of Governors of th...
Book
Over-the-counter (OTC) markets for derivatives, collateralized debt obligations, and repurchase agreements played a significant role in the global financial crisis. Rather than being traded through a centralized institution such as a stock exchange, OTC trades are negotiated privately between market participants who may be unaware of prices that ar...
Article
Full-text available
Abstract We state a theorem on the existence of equilibrium in a continuous-time finance model with multiple agents, including the case of dynamically in- complete markets as well as dynamically complete markets. In the case of dynamically incomplete markets, equilibrium prices may be discontinuous, even if all economically relevant primitives of t...
Article
Full-text available
Here, I present and discuss a “10-by-10-by-10” network-based approach to monitoring systemic financial risk. Under this approach, a regulator would analyze the exposures of a core group of systemically important financial firms to a list of stressful scenarios, say 10 in number. For each scenario, about 10 such designated firms would report their g...
Article
We calculate equilibria of dynamic double-auction markets in which agents are distinguished by their preferences and information. Over time, agents are privately informed by bids and offers. Investors are segmented into groups that differ with respect to characteristics determining information quality, including initial information precision as wel...
Article
We present a model for the equilibrium movement of capital between asset markets that are distinguished only by the levels of capital invested in each. Investment in that market with the greatest amount of capital earns the lowest risk premium. Intermediaries optimally trade off the costs of intermediation against fees that depend on the gain they...
Book
This book, based on the author's Clarendon Lectures in Finance, examines the empirical behaviour of corporate default risk. A new and unified statistical methodology for default prediction, based on stochastic intensity modeling, is explained and implemented with data on U.S. public corporations since 1980. Special attention is given to the measure...
Article
This paper develops a formula for a transform of a vector point process with totally inaccessible arrivals. The transform is expressed in terms of a Laplace trans-form under an equivalent probability measure of the point process compensator. The Laplace transform of the compensator can be calculated explicitly for a wide range of model specificatio...
Article
We show whether central clearing of a particular class of derivatives lowers counterparty risk. For plausible cases, adding a central clearing counterparty (CCP) for a class of derivatives such as credit default swaps reduces netting efficiency, leading to an increase in average exposure to counterparty default. Further, clearing different classes...
Article
This note discusses the case for exempting foreign exchange derivatives from recent regulatory requirements for over-the-counter derivatives, including clearing, trade competition, and minimum collateral requirements. My conclusion is that the arguments that have been made for such an exemption are not sufficient. I focus mainly on the question of...
Article
Rating agencies are often criticized for being biased in favor of borrowers, for being too slow to downgrade following credit quality deterioration, and for being oligopolists. Based on a model that takes into account the feedback effects of credit ratings, I show that: (i) a rating agency should focus not only on the accuracy of its ratings but al...
Article
The current stable-NAV model for prime money market funds exposes fund investors and systemically important borrowers to runs like those that occurred after the failure of Lehman in September 2008. This working paper, by the Squam Lake Group, argues that, to reduce this risk, funds should have either floating NAVs or buffers provided by their spons...
Article
Dealer banks--that is, large banks that deal in securities and derivatives, such as J. P. Morgan and Goldman Sachs--are of a size and complexity that sharply distinguish them from typical commercial banks. When they fail, as we saw in the global financial crisis, they pose significant risks to our financial system and the world economy. How Big Ban...
Article
Over-the-counter (OTC) markets for derivatives, collateralized debt obligations, and repurchase agreements played a significant role in the global financial crisis. Rather than being traded through a centralized institution such as a stock exchange, OTC trades are negotiated privately between market participants who may be unaware of prices that ar...
Article
We examine the information content of option and equity volumes when trade di-rection is unobserved. In a multimarket asymmetric information model, we show that equity short-sale costs result in a negative relation between relative option volume and future firm value. In our empirical tests, firms in the lowest decile of the option to stock volume...
Article
Full-text available
I develop a two-country general equilibrium model with firms, governments, and endogenous default decisions. This paper shows that the risk of sovereign default abroad is important in the explanation of the level and the volatility of U.S. equity returns. The intuition is that negative economic shocks deteriorate the fiscal situation of foreign gov...
Article
I describe asset price dynamics caused by the slow movement of investment capital to trading opportunities. The pattern of price responses to supply or demand shocks typically involves a sharp reaction to the shock and a subsequent and more extended reversal. The amplitude of the immediate price impact and the pattern of the subsequent recovery can...
Article
Full-text available
We model the capital allocation decision of informed traders with access to equity and option markets. Equity short sale costs lead informed traders to use options more frequently for negative signals. In our empirical tests, firms in the lowest decile of the ratio of option to equity volume (OVR) outperform those in the highest decile by 1.47% per...
Article
We calculate learning rates when agents are informed through both public and private observation of other agents’ actions. We provide an explicit solution for the evolution of the distribution of posterior beliefs. When the private learning channel is present, we show that convergence of the distribution of beliefs to the perfect-information limit...
Article
In these excerpts from The Squam Lake Report, fifteen distinguished economists analyze where the global financial system failed, and how such failures might be prevented (or at least their damage better contained) in the future. Although there were many contributing factors to the crisis—including “agency” problems throughout the financial system a...
Article
Full-text available
We study the "percolation" of information of common interest through a large market as agents encounter and reveal information to each other over time. We provide an explicit solution for the dynamics of the cross-sectional distribution of posterior beliefs. We also show that convergence of the cross-sectional distribution of beliefs to a common po...
Article
During the recent financial crisis, major dealer banks -- that is, banks that intermediate markets for securities and derivatives -- suffered from new forms of bank runs. The most vivid examples are the 2008 failures of Bear Stearns and Lehman Brothers. Dealer banks are often parts of large complex financial organizations whose failures can damage...
Book
This is a thoroughly updated edition of Dynamic Asset Pricing Theory, the standard text for doctoral students and researchers on the theory of asset pricing and portfolio selection in multiperiod settings under uncertainty. The asset pricing results are based on the three increasingly restrictive assumptions: absence of arbitrage, single-agent opti...
Article
Full-text available
I address whether speculation in credit default swaps is likely to have driven up Eurozone sovereign borrowing costs. I provide empirical evidence, based on research in progress with Zhipeng Zhang, that this is not the case. I also describe the role of speculators in credit default swap markets. I discuss how regulations that severely restrict spec...
Article
In the wake of the recent financial crisis, over-the-counter (OTC) derivatives have been blamed for increasing systemic risk. Although OTC derivatives were not a central cause of the crisis, the complexity and limited transparency of the market reinforced the potential for excessive risk-taking, as regulators did not have a clear view into how OTC...
Article
In the wake of the recent financial crisis, over-the-counter (OTC) derivatives have been blamed for increasing systemic risk. Although OTC derivatives were not a central cause of the crisis, the complexity and limited transparency of the market reinforced the potential for excessive risk-taking, as regulators did not have a clear view into how OTC...
Article
In the wake of the recent financial crisis, over-the-counter (OTC) derivatives have been blamed for increasing systemic risk. Although OTC derivatives were not a central cause of the crisis, the complexity and limited transparency of the market reinforced the potential for excessive risk-taking, as regulators did not have a clear view into how OTC...
Article
Full-text available
This article develops a framework that combines the economics behind the structural modeling of sovereign credit risk, corporate capital structure, and the equilibrium modeling of international asset pricing. The default decisions of the sovereign and the firm are derived optimally and embedded in a two-country, two-good consumption-based asset-pri...
Article
The probability of extreme default losses on portfolios of U.S. corporate debt is much greater than would be estimated under the standard assumption that default correlation arises only from exposure to observable risk factors. At the high confidence levels at which bank loan portfolio and collateralized debt obligation (CDO) default losses are typ...
Article
Full-text available
This paper uses option prices to learn about the uncertainty surrounding the fun-damental information that is revealed on earnings announcement dates. To do this, we introduce a reduced-form model and estimators to separate the uncertainty over the information revealed on earnings dates from normal day-to-day volatility. The fundamental uncertainty...
Article
Full-text available
Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hard-to-borrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. A part of the value of failing passes through to options prices: when failing is cheaper than borrowing, t...
Article
Full-text available
Disclosure of information triggers immediate price movements, but it mitigates price movements at a later date, when the information would otherwise have become public. Consequently, disclosure shifts risk from later cohorts of investors to earlier cohorts. Hence, disclosure policy can be interpreted as a tool to "control" interim price movements,...
Article
Full-text available
We solve for the equilibrium dynamics of information sharing in a large population. Each agent is endowed with signals regarding the likely outcome of a random variable of common concern. Individuals choose the effort with which they search for others from whom they can gather additional information. When two agents meet, they share their informati...
Preprint
For a setting in which a large number of asymmetrically informed agents are randomly matched into groups over time, exchanging their information with each other when matched, we provide an explicit solution for the dynamics of the cross-sectional distribution of posterior beliefs. We also show that convergence of the cross-sectional distribution of...
Article
Intuition suggests that firms with higher cash holdings are safer and should have lower credit spreads. Yet empirically the correlation between cash and spreads is robustly positive, and higher for lower credit ratings. This puzzling finding can be explained by the precautionary motive for saving cash. In our model endogenously determined optimal c...
Article
This panel session, prompted by the financial crisis of 2007-2008, focuses on issues related to the soundness and regulation of financial firms that are not necessarily traditional banks, at times of crises in financial stability. An example is the demise of Bear Stearns. The focus of the panel is not only what happened, but also what should have h...
Article
Banks and other lenders often transfer credit risk to liberate capital for further loan intermediation. This paper aims to explore the design, prevalence and effectiveness of credit risk transfer (CRT). The focus is on the costs and benefits for the efficiency and stability of the financial system. After an overview of recent credit risk transfer a...
Article
This is a preliminary study on the status of the U.S. in the global market for derivatives-related services. We include some of the policy choices available to enhance this status. We begin with a review of the importance of active and efficient derivatives markets for the U.S. economy. We then analyze the status of U.S. derivatives-market service...
Article
We study the cross-section of stock option returns by constructing decile portfolios of straddles and delta-hedged calls and puts based on sorting stocks on the differ-ence between historical realized volatility and at-the-money implied volatility. We find that a zero-cost trading strategy that is long (short) in the portfolio with a large positive...
Article
Full-text available
The puzzle is that spreads on corporate bonds are about twice as large as can be explained by defaults, taxes and illiquidity. The higher a bond's rating and the shorter its maturity, the greater is the puzzle. We use a large dataset of bonds to identify the relevant risk factors. Systematic factors fail to generate large spreads, regardless of whe...
Article
This paper provides evidence that the positive relation between firm-level stock returns and firm-level return volatility is due to real options that firms possess. Consistent with the theoretical prediction that the value of a real option should be increasing in the volatility of the underlying asset, we find that the positive volatility-return re...
Article
Banks and other lenders often transfer credit risk in order to liberate capi- tal for further loan intermediation. Beyond selling loans outright, lenders are increasingly active in the markets for syndicated loans, collateralized loan obliga- tions (CLOs), credit default swaps, credit derivative product companies, "spe- cialty finance companies," a...
Chapter
We provide an approach to the market valuation of deposit insurance that is based on reduced-form methods for the pricing of fixed-income securities under default risk. By reference to bank debt prices as well as qualitativeresponse models of the probability of bank failure, we suggest how a risk-neutral valuation model for deposit insurance can be...
Article
We derive a formula for a Fourier transform of a counting process that describes the arrival of unpredictable events, and we show how this transform facilitates an an-alytical treatment of a range of valuation, hedging and risk management problems that arise in single name and portfolio credit risk. Example applications include reduced form pricing...
Article
It is often the case that banks in the US are willing to borrow in the fed funds market (the interbank market for funds) at higher rates than the ones they could obtain by borrowing at the Fed's discount window. This phenomenon is commonly explained as the consequence of the existence of a stigma effect attached to borrowing from the window. Most p...
Article
Full-text available
Children in households reporting the receipt of free or reduced price school meals through the National School Lunch Program (NSLP) are more likely to have negative health outcomes than eligible nonparticipants. Assessing the causal effects of the program is made difficult, however, by the presence of endogenous selection into the program and syste...

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