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Working Paper
Can Models with Idiosyncratic Risk Solve the Equity Premium Puzzle? Redux
Can idiosyncratic risk explain the equity premium? We revisit this question using a novel measure of imperfect risk sharing, implied by a large class of heterogeneous-agent models, constructed using household-level panel data. We identify a group of households – with relatively high income but low net worth – whose consumption is sufficiently volatile and risky to explain 94% of the observed U.S. Sharpe ratio. In contrast, the consumption dynamics of high net-worth individuals predict a negative Sharpe ratio and so do not constitute the relevant pricing factor, consistent with models ...
Working Paper
Low Risk Sharing with Many Assets
Classical contributions in international macroeconomics rely on goods-market mechanisms to reconcile the cyclicality of real exchange rates when financial markets are incomplete. However, cross-border trade in one domestic and one foreign-currency-denominated risk-free asset prohibits these mechanisms from breaking the pattern consistent with complete markets. In this paper, we characterize how goods markets drive exchange rate cyclicality, taking into account trade in risk-free and/or risky assets. We show that goods-market mechanisms come back into play, even when there is cross-border ...
Working Paper
Incomplete Markets and Exchange Rates
We show imperfect risk-sharing within countries can reconcile the aggregate cyclicality of exchange rates in a two-country setting, i.e. the Backus-Smith puzzle, as long as exchange rates are sufficiently risky with respect to idiosyncratic states. In equilibrium, these exchange rate dynamics require that, despite a country experiencing higher consumption growth, idiosyncratic risk remains relatively elevated. Furthermore, we identify distinct roles for market incompleteness both within and across countries, to match key moments of exchange rates. Turning to household-level data, we measure ...
Working Paper
Incomplete Markets and Exchange Rates
We show imperfect risk-sharing within countries can reconcile the aggregate cyclicality of exchange rates in a two-country setting, i.e. the Backus-Smith puzzle, as long as exchange rates are sufficiently risky with respect to idiosyncratic states. In equilibrium, these exchange rate dynamics require that, despite a country experiencing higher consumption growth, idiosyncratic risk remains relatively elevated. Furthermore, we identify distinct roles for market incompleteness both within and across countries, to match key moments of exchange rates. Turning to household-level data, we measure ...