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143
Variable Rare Disasters: An Exactly Solved Framework for
 Ten Puzzles in Macro Finance, Working Paper, NYU
, 2009
"... This article incorporates a timevarying severity of disasters into the hy ..."
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Cited by 163 (10 self)
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This article incorporates a timevarying severity of disasters into the hy
Why is longhorizon equity less risky? A durationbased explanation of the value premium, NBER working paper
, 2005
"... We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model im ..."
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Cited by 105 (21 self)
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We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model implies that growth firms covary more with the discount rate than do value firms, which covary more with cash flows. When calibrated to explain aggregate stock market behavior, the model accounts for the observed value premium, the high Sharpe ratios on value firms, and the poor performance of the CAPM. THIS PAPER PROPOSES A DYNAMIC RISKBASED MODEL that captures both the high expected returns on value stocks relative to growth stocks, and the failure of the capital asset pricing model to explain these expected returns. The value premium, first noted by Graham and Dodd (1934), is the finding that assets with a high ratio of price to fundamentals (growth stocks) have low expected returns relative to assets with a low ratio of price to fundamentals (value stocks). This
A PreferredHabitat Model of the Term Structure of Interest Rates,” NBER Working Paper 15487
, 2009
"... We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and riskaverse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles ’ demand for bonds affect the term structure— and constitute a ..."
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Cited by 90 (5 self)
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We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and riskaverse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles ’ demand for bonds affect the term structure— and constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitragefree, demand effects satisfy noarbitrage restrictions and can be quite different from the underlying shocks. We show that the preferredhabitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to shortrate expectations, the economic role of carry trades, and the transmission of monetary policy.
HabitBased Explanation of the Exchange Rate Risk Premium
, 2005
"... This paper presents a fully rational general equilibrium model that produces a timevarying exchange rate risk premium and solves the uncovered interest rate parity (U.I.P) puzzle. In this twocountry model, agents are characterized by slowmoving external habit preferences derived from Campbell & ..."
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Cited by 87 (5 self)
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This paper presents a fully rational general equilibrium model that produces a timevarying exchange rate risk premium and solves the uncovered interest rate parity (U.I.P) puzzle. In this twocountry model, agents are characterized by slowmoving external habit preferences derived from Campbell & Cochrane (1999). Endowment shocks are i.i.d and real riskfree rates are timevarying. Agents can trade across countries, but when a unit is shipped, only a fraction of the good arrives to the foreign shore. The model gives a rationale for the U.I.P puzzle: the domestic investor receives a positive exchange rate risk premium when she is more riskaverse than her foreign counterpart. Times of high riskaversion correspond to low interest rates. Thus, the domestic investor receives a positive risk premium when interest rates are lower at home than abroad. The model is both simulated and estimated. The simulation recovers the usual negative coefficient between exchange rate variations and interest rate differentials. When the iceberglike trade cost is taken into account, the exchange rate variance produced is in line with its empirical counterpart. A nonlinear estimation of the model using consumption data leads to reasonable parameters when pricing the foreign excess returns of an American investor.
The Bond Premium in a DSGE Model with LongRun Real and Nominal Risks
, 2009
"... The term premium on nominal longterm bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data — an example of the “bond premium puzzle.” However, in models of endowment economie ..."
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Cited by 83 (4 self)
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The term premium on nominal longterm bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data — an example of the “bond premium puzzle.” However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors have recursive EpsteinZin preferences and face longrun economic risks. We show that introducing EpsteinZin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model’s ability to fit key macroeconomic variables. Longrun real and nominal risks further improve the model’s ability to fit the data with a lower level of household risk aversion.
Risk Premiums in Dynamic Term Structure Models with . . .
, 2010
"... This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and ..."
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Cited by 66 (10 self)
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This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and inflation risks – impact bond investment decisions separately from information about the shape of the yield curve. Estimates of our preferred macroDT SM over the twentythree year period from 1985 through 2007 reveal that unspanned macro risks explained a substantial proportion of the variation in forward terms premiums. Unspanned macro risks accounted for nearly 90 % of the conditional variation in shortdated forward term premiums, with unspanned real economic growth being the key driving factor. Over horizons beyond three years, these effects were entirely attributable to unspanned inflation. Using our model, we also reassess some of Chairman Bernanke’s remarks on the interplay between term premiums, the shape of the yield curve, and macroeconomic activity.
NoArbitrage Macroeconomic Determinants of the Yield Curve,” Working paper
, 2005
"... Montreal, the CEPR meetings at Gerzensee, Econometric World Congress in London, EFA in Moscow, NYU Stern ..."
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Cited by 49 (2 self)
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Montreal, the CEPR meetings at Gerzensee, Econometric World Congress in London, EFA in Moscow, NYU Stern
Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds
, 2007
"... The covariance between US Treasury bond returns and stock returns has moved considerably over time. While it was slightly positive on average in the period 1953— 2005, it was particularly high in the early 1980’s and negative in the early 2000’s. This paper specifies and estimates a model in which t ..."
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Cited by 49 (10 self)
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The covariance between US Treasury bond returns and stock returns has moved considerably over time. While it was slightly positive on average in the period 1953— 2005, it was particularly high in the early 1980’s and negative in the early 2000’s. This paper specifies and estimates a model in which the nominal term structure of interest rates is driven by five state variables: the real interest rate, risk aversion, temporary and permanent components of expected inflation, and the covariance between nominal variables and the real economy. The last of these state variables enables the model to fit the changing covariance of bond and stock returns. Log nominal bond yields and term premia are quadratic in these state variables, with term premia determined mainly by the product of risk aversion and the nominalreal covariance. The concavity of the yield curve–the level of intermediateterm bond yields, relative to the average of short and longterm bond yields–is a good proxy for the level of term premia. The nominalreal covariance has declined since the early 1980’s, driving down term premia.
Financial Markets and the Real Economy
, 2006
"... I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” ..."
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Cited by 44 (4 self)
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I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” I survey the literature, covering the timeseries and crosssectional facts, the equity premium, consumptionbased models, general equilibrium models, and labor income/idiosyncratic risk approaches.