Research

“In God we trust; all others must bring data.”   W. Edwards Deming.

Working Papers:
Babak Lotfaliei, 2017, "The Variance Risk Premium and Capital Structure", Working paper, August, San Diego State University (First version: November 2011, R&R Journal of Financial and Quantitative Analysis, JFQA)
  • Abstract:
This paper investigates how the asset-return variance risk premium changes firm leverage. I find that the premium lowers leverage by increasing risk-neutral bankruptcy probability and costs in a model where asset returns have stochastic variance with risk premium. Empirically, the model calibrations verify significant reduction in optimal leverage, closer to observed leverage than the model without the premium. In model-free regressions, I also document negative correlation between leverage and variance premium. The most negative correlation is among investment-grade firms with low asset beta and historical variance but high variance premium because their assets have high exposure to market variance premium.
 
  • The best paper award semi-finalist in Financial Management Association (FMA) 2015 meeting
SDSU finance seminar, McGill University finance seminar, Mathematical finance days 2014, MidWest Finance Association (MFA) meeting 2015, Global Finance Conference 2016

Babak Lotfaliei, 2016, "Zero Leverage and The Value in Waiting to Issue Debt*", Working Paper, June, San Diego State University (First version: March 2013, R&R Journal of Banking and Finance, JBF
  • Abstract:
This article documents that the real option to have debt motivates some fi.rms to remain debt-free, even when standard trade-off theory predicts that these fi.rms should have leverage. The real option has a fi.rst-order effect similar to bankruptcy costs in addressing the zero-leverage puzzle, the observation that many fi.rms seemingly forgo sizable debt benefits by remaining debt-free. The debt-free fi.rms' value includes the option whose value is
derived from future debt bene.fits and hedging bankruptcy costs. This article proposes an optimal timing model for having debt and .finds support for the model's predictions through simulations and empirical analysis.
 
UCSD Raddy School of Business seminar, SDSU Finance seminar, European Financial Management Association (EFMA) 2014, Northern Finance Association 2014 meeting, Mathematical finance days 2014, 8th National University of Singapore RMI conference (2014) 
*:formerly titled "The value in waiting to issue debt"   

Jan Ericsson, Babak Lotfaliei, 2017, "The Variance Risk Premium and Investment Uncertainty", Working paper, July (First version: July 2014)
  • Abstract:
This article documents that the variance risk premium in asset returns decreases firms' investment. In our model, the premium increases the value of the real option to postpone an irreversible investment. In our data, we find support for a negative relationship between variance risk premia and firms' rate of investment. The relation is more important for investment-grade firms, which tend to have low historical variance but relatively high variance risk premia. Controlling for this premium allows us to reconcile an otherwise surprising pattern across credit ratings: investment rates are higher for speculative grade than investment grade firms.


Global Finance Conference 2016, 
Financial Management Association (FMA) 2016 meeting, Finance Forum (Barcelona) 2017

Amir Akbari, Babak Lotfaliei, 2015, "International Correlation Premium in the Stock Markets", Working paper, December, San Diego State University 
  • Abstract:
Historically, correlations among international markets have doubled in the past 30 years from 40% to 80%. An increasing correlation implies that the diversification benefits from investing in different countries decrease. This phenomenon is analogical to observed correlation among stocks in the US stock market, but in a larger scale. There is evidence on priced correlation risk among the stocks in the US market. This project extends the correlation-risk idea to the international markets: Did markets consider the increasing trend of the correlation and allocate a premium to that? How big is the correlation risk premium among the international markets? If correlation has priced risk, risk-adjusted (RA) correlation is expected to be larger than historical correlation; market has predicted that correlation is risky and already has taken that into account. Otherwise, RA correlation is equal to historical correlation if correlation is not risky. In addition to portfolio management implications, the outcome of this project has implications for pricing index and stock options worldwide.

For more information please see my CV.