Search Results
Working Paper
Too Good to Be True? Fallacies in Evaluating Risk Factor Models
This paper is concerned with statistical inference and model evaluation in possibly misspecified and unidentified linear asset-pricing models estimated by maximum likelihood and one-step generalized method of moments. Strikingly, when spurious factors (that is, factors that are uncorrelated with the returns on the test assets) are present, the models exhibit perfect fit, as measured by the squared correlation between the model's fitted expected returns and the average realized returns. Furthermore, factors that are spurious are selected with high probability, while factors that are useful are ...
Working Paper
Asymptotic variance approximations for invariant estimators in uncertain asset-pricing models
This paper derives explicit expressions for the asymptotic variances of the maximum likelihood and continuously updated GMM estimators under potentially misspecified models. The proposed misspecification-robust variance estimators allow the researcher to conduct valid inference on the model parameters even when the model is rejected by the data. Although the results for the maximum likelihood estimator are only applicable to linear asset-pricing models, the asymptotic distribution of the continuously updated GMM estimator is derived for general, possibly nonlinear, models. The large ...
Working Paper
What we learn from China's rising shadow banking: exploring the nexus of monetary tightening and banks' role in entrusted lending
We argue that China's rising shadow banking was inextricably linked to potential balance-sheet risks in the banking system. We substantiate this argument with three didactic findings: (1) commercial banks in general were prone to engage in channeling risky entrusted loans; (2) shadow banking through entrusted lending masked small banks' exposure to balance-sheet risks; and (3) two well-intended regulations and institutional asymmetry between large and small banks combined to give small banks an incentive to exploit regulatory arbitrage by bringing off-balance-sheet risks into the balance ...
Working Paper
Spurious Inference in Unidentified Asset-Pricing Models
This paper studies some seemingly anomalous results that arise in possibly misspecified and unidentified linear asset-pricing models estimated by maximum likelihood and one-step generalized method of moments (GMM). Strikingly, when useless factors (that is, factors that are independent of the returns on the test assets) are present, the models exhibit perfect fit, as measured by the squared correlation between the model's fitted expected returns and the average realized returns, and the tests for correct model specification have asymptotic power that is equal to the nominal size. In other ...
Working Paper
Liquidity Premia, Price-Rent Dynamics, and Business Cycles
n the U.S. economy during the past 25 years, house prices exhibit fluctuations considerably larger than house rents, and these large fluctuations tend to move together with business cycles. We build a simple theoretical model to characterize these observations by showing the tight connection between price-rent fluctuation and the liquidity constraint faced by productive firms. After developing economic intuition for this result, we estimate a medium-scale dynamic general equilibrium model to assess the empirical importance of the role the price-rent fluctuation plays in the business cycle. ...
Working Paper
General Aggregation of Misspecified Asset Pricing Models
This paper proposes an entropy-based approach for aggregating information from misspecified asset pricing models. The statistical paradigm is shifted away from parameter estimation of an optimally selected model to stochastic optimization based on a risk function of aggregation across models. The proposed method relaxes the perfect substitutability of the candidate models, which is implicitly embedded in the linear pooling procedures, and ensures that the aggregation weights are selected with a proper (Hellinger) distance measure that satisfies the triangle inequality. The empirical results ...
Working Paper
Discount Shock, Price-Rent Dynamics, and the Business Cycle
The price-rent ratio in commercial real estate is highly volatile, and its variation comoves with the business cycle. To account for these two facts, we develop a dynamic general equilibrium model that explicitly introduces a rental market and incorporates the liquidity constraint on an individual firm's production as a key ingredient. Our estimation identifies the discount shock as the most important factor in driving price-rent dynamics and linking the dynamics in the real estate market to those in the real economy. We illustrate the importance of the liquidity premium and endogenous total ...
Working Paper
Show me the money: the monetary policy risk premium
We study how monetary policy affects the cross-section of expected stock returns. For this purpose, we create a parsimonious monetary policy exposure (MPE) index based on observable firm characteristics that are theoretically linked to how firms react to monetary policy. We find that stocks whose prices react more positively to expansionary monetary policy surprises earn lower average returns. This finding is consistent with the intuition that monetary policy is expansionary in bad economic times when the marginal value of wealth is high, and thus high MPE stocks serve as a hedge against bad ...
Working Paper
A Currency Premium Puzzle
Standard asset pricing models reconcile high equity premia with smooth risk-free rates by inducing an inverse functional relationship between the mean and the variance of the stochastic discount factor. This highly successful resolution to closed-economy asset pricing puzzles is fundamentally problematic when applied to open economies: It requires that differences in currency returns arise almost exclusively from predictable appreciations, not from interest rate differentials. In the data, by contrast, exchange rates are largely unpredictable, and currency returns arise from persistent ...
Working Paper
The Effect of the Federal Reserve on the Stock Market: Magnitudes, Channels and Shocks
We survey and extend work on the Federal Reserve’s effect on the stock market, focusing on three empirical findings: The effect of monetary policy surprises in a narrow window around announcements from the Federal Open Market Committee (FOMC), the pre-FOMC announcement drift, and the FOMC cycle in stock returns. We discuss the magnitude of the Fed’s impact (directional effects or effects on average stock returns), the types of shocks coming from the Fed (pure monetary policy shocks, reaction function news, or information about the Fed’s view of the economy), and the asset pricing ...