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Working Paper
Accounting for Macro-Finance Trends: Market Power, Intangibles, and Risk Premia
Real risk-free interest rates have trended down over the past 30 years. Puzzlingly in light of this decline, (1) the return on private capital has remained stable or even increased, creating an increasing wedge with safe interest rates; (2) stock market valuation ratios have increased only moderately; (3) investment has been lackluster. We use a simple extension of the neoclassical growth model to diagnose the nexus of forces that jointly accounts for these developments. We find that rising market power, rising unmeasured intangibles, and rising risk premia, play a crucial role, over and ...
Working Paper
Asset Return Dynamics under Habits and Bad-Environment Good-Environment Fundamentals
We introduce a "bad environment-good environment" (BEGE) technology for consumption growth in a consumption-based asset pricing model with external habit formation. The model generates realistic non-Gaussian features of consumption growth and fits standard salient features of asset prices including the means and volatilities of equity returns and a low risk free rate. BEGE dynamics additionally allow the model to generate realistic properties of equity index options prices, and their comovements with the macroeconomic outlook. In particular, when option implied volatility is high, as ...
Working Paper
Does Smooth Ambiguity Matter for Asset Pricing?
We use the Bayesian method introduced by Gallant and McCulloch (2009) to estimate consumption-based asset pricing models featuring smooth ambiguity preferences. We rely on semi-nonparametric estimation of a flexible auxiliary model in our structural estimation. Based on the market and aggregate consumption data, our estimation provides statistical support for asset pricing models with smooth ambiguity. Statistical model comparison shows that models with ambiguity, learning and time-varying volatility are preferred to the long-run risk model. We analyze asset pricing implications of the ...
Working Paper
Idiosyncratic Investment Risk and Business Cycles
I show that, due to imperfect risk sharing, aggregate shocks to uncertainty about idiosyncratic return on investment generate economic contractions with elevated risk premia and a decrease in the risk-free rate. I present a tractable real business cycle model in which firms experience idiosyncratic shocks, to which managers are at least partially exposed; the distribution of these shocks is time-varying and stochastic. I show that the path for aggregate quantities, the price of physical capital, and the equity premium are the same as in a model without idiosyncratic risk, but with ...
Discussion Paper
What’s Up with Stocks?
“U.S. stocks are racing toward a second consecutive quarter of dramatic gains, continuing a historic stock-market recovery that few predicted in the depths of the March downturn,” said a September Wall Street Journal article. “The stock market is detached from economic reality. A reckoning is coming,” said the Washington Post. What is going on? In this post, I look not at what stocks have actually done or will do, but at what investors expected should have happened, and what they expect will happen going forward. It turns out that, at least by the particular measure of expectations I ...
Report
The equity risk premium: a review of models
We estimate the equity risk premium (ERP) by combining information from twenty models. The ERP in 2012 and 2013 reached heightened levels?of around 12 percent?not seen since the 1970s. We conclude that the high ERP was caused by unusually low Treasury yields.
Working Paper
The other (commercial) real estate boom and bust: the effects of risk premia and regulatory capital arbitrage
The last decade?s boom and bust in U.S. commercial real estate (CRE) prices was at least as large as that in the housing market and also had a large effect on bank failures. Nevertheless, the role of CRE in the Great Recession has received little attention. This study estimates cohesive models of short-run and long-run movements in capitalization rates (rent-to-price-ratio) and risk premiums across the four major types of commercial properties. Results indicate that CRE price movements were mainly driven by sharp declines in required risk premia during the boom years, followed by sharp ...