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Working Paper
Risk Premia at the ZLB: A Macroeconomic Interpretation
Historically, inflation is negatively correlated with stock returns, leading investors to fear inflation. We document using a variety of measures that this association became positive in the U.S. during the 2008-2015 period. We then show how an off-the-shelf New Keynesian model can reproduce this change of association due to the binding zero lower bound (ZLB) on short-term nominal interest rates during this period: in the model, demand shocks become more important when the ZLB binds because the central bank cannot respond as effectively as when interest rates are positive. This changing ...
Report
Uncertainty Shocks, Capital Flows, and International Risk Spillovers
Foreign investors’ changing appetite for risk-taking has been shown to be a key determinant of the global financial cycle. Such fluctuations in risk sentiment also correlate with the dynamics of uncovered interest parity (UIP) premia, capital flows, and exchange rates. To understand how these risk sentiment changes transmit across borders, we propose a two-country macroeconomic framework. Our model features cross-border holdings of risky assets by U.S. financial intermediaries that operate under financial frictions and act as global intermediaries in that they take on foreign asset risk. In ...
Working Paper
Risk Premia at the ZLB: A Macroeconomic Interpretation
Historically, inflation is negatively correlated with stock returns, leading investors to fear inflation. We document using a variety of measures that this association became positive in the U.S. during the 2008-2015 period. We then show how an off-the-shelf New Keynesian model can reproduce this change of association due to the binding zero lower bound (ZLB) on short-term nominal interest rates during this period: in the model, demand shocks become more important when the ZLB binds because the central bank cannot respond as effectively as when interest rates are positive. This changing ...
Working Paper
Explaining the Great Moderation Exchange Rate Volatility Puzzle
In this paper, we study how the volatility of both realized and expected macroeconomic variables relates to the variation in exchange rate volatility through the prism of the Great Moderation hypothesis. We find significant heterogeneity in exchange rate trend volatility across currency pairs despite decreases in the volatility of expected future interest rate differentials and of realized yields themselves. We argue that time variation in the relationship between macroeconomic variables and exchange rates has prevented the Great Moderation in realized yield volatility from translating to a ...
Report
Uncertainty Shocks, Capital Flows, and International Risk Spillovers
Foreign investors’ changing appetite for risk-taking has been shown to be a key determinant of the global financial cycle. Such fluctuations in risk sentiment also correlate with the dynamics of uncovered interest parity (UIP) premia, capital flows, and exchange rates. To understand how these risk sentiment changes transmit across borders, we propose a two-country macroeconomic framework. Our model features cross-border holdings of risky assets by U.S. financial intermediaries that operate under financial frictions and act as global intermediaries in that they take on foreign asset risk. In ...
Working Paper
Risk-Adjusted Capital Allocation and Misallocation
We develop a theory linking “misallocation,” i.e., dispersion in marginal products of capital (MPK), to macroeconomic risk. Dispersion in MPK depends on (i) heterogeneity in firm-level risk premia and (ii) the price of risk, and thus is countercyclical. We document strong empirical support for these predictions. Stock market-based measures of risk premia imply that risk considerations explain about 30% of observed MPK dispersion among US firms and rationalize a large persistent component in firm-level MPK. Risk-based MPK dispersion, although not prima facie inefficient, lowers long-run ...
Working Paper
Cross-Policy Risk Pricing
We show that interactions across government policies affect firms’ cost of equity capital. Exploiting the 2018–2019 U.S. tariff shocks and concurrent federal procurement spending, we find that firms facing higher tariff exposure earn higher subsequent risk premia, but this effect is substantially attenuated for firms receiving greater procurement. A one-standard-deviation increase in procurement attenuates about two-thirds of the tariff-related risk premium. Procurement is relatively more favorable for politically connected and economically vulnerable firms. Larger procurement inflows ...
Working Paper
High Discounts and Low Fundamental Surplus: An Equivalence Result for Unemployment Fluctuations
Ljungqvist and Sargent (2017) (LS) show that unemployment fluctuations can be understoodin terms of a quantity they call the “fundamental surplus.” However, their analysis ignores riskpremia, a force that Hall (2017) shows is important in understanding unemployment fluctuations. Weshow how the LS framework can be adapted to incorporate risk premia. We derive an equivalenceresult that relates parameters in economies with risk premia to those of an artificial economy withoutrisk premia. We show how to use properties of the artificial economy to deduce how risk premia affectunemployment ...