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60
Consumption Strikes Back? Measuring LongRun Risk
, 2008
"... We characterize and measure a longterm riskreturn tradeoff for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This tradeoff features risk prices of cash flows that are realized far into the future but continue to be reflected in asset values. We apply this analysis ..."
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Cited by 230 (31 self)
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We characterize and measure a longterm riskreturn tradeoff for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This tradeoff features risk prices of cash flows that are realized far into the future but continue to be reflected in asset values. We apply this analysis to claims on aggregate cash flows and to cash flows from value and growth portfolios by imputing values to the longrun dynamic responses of cash flows to macroeconomic shocks. We explore the sensitivity of our results to features of the economic valuation model and of the model cash flow dynamics.
The Dynamics Effects of Neutral and InvestmentSpecific Technology Shocks
 Journal of Political Economy
"... The neoclassical growth model is used to identify the short run effects of two technology shocks. Neutral shocks affect the production of all goods homogeneously, and investmentspecific shocksaffect only investment goods. The paper finds that previous estimates, based on considering only neutral te ..."
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Cited by 177 (2 self)
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The neoclassical growth model is used to identify the short run effects of two technology shocks. Neutral shocks affect the production of all goods homogeneously, and investmentspecific shocksaffect only investment goods. The paper finds that previous estimates, based on considering only neutral technical change, substantially understate the effects of technology shocks. When investmentspecific technical change is taken into account, the two technology shocks combined account for 4060 % of the fluctuations in output and hours at business cycle frequencies. The two shocks also account for more than 50 % of the forecast error of output and hours over an eight year horizon. The investmentspecific shocks account for the majority of these short run effects. This paper is a substantial revision to “Technology Shocks Matter. ” Thanks to Lisa Barrow, Lawrence
Longrun risk through consumption smoothing
 Review of Financial Studies
, 2010
"... We examine how longrun consumption risk arises endogenously in a standard production economy model where the representative agent has EpsteinZin preferences. Even when technology growth is i.i.d., optimal consumption smoothing induces highly persistent timevariation in expected consumption growt ..."
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Cited by 42 (1 self)
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We examine how longrun consumption risk arises endogenously in a standard production economy model where the representative agent has EpsteinZin preferences. Even when technology growth is i.i.d., optimal consumption smoothing induces highly persistent timevariation in expected consumption growth (longrun risk). This increases the price of risk when investors prefer early resolution of uncertainty, and the model can then account for the low volatility of consumption growth and the high price of risk with a low coe ¢ cient of relative risk aversion. The asset price implications of endogenous longrun risk depends crucially on the persistence of technology shocks and investors preference for the timing of resolution of uncertainty.
The Term Structure of Interest Rates in a DSGE Model with Recursive Preferences
, 2010
"... We solve a dynamic stochastic general equilibrium (DSGE) model in which the representative household has Epstein and Zin recursive preferences. The parameters governing preferences and technology are estimated by means of maximum likelihood using macroeconomic data and asset prices, with a particul ..."
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Cited by 31 (2 self)
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We solve a dynamic stochastic general equilibrium (DSGE) model in which the representative household has Epstein and Zin recursive preferences. The parameters governing preferences and technology are estimated by means of maximum likelihood using macroeconomic data and asset prices, with a particular focus on the term structure of interest rates. We estimate a large risk aversion, an elasticity of intertemporal substitution higher than one, and substantial adjustment costs. Furthermore, we identify the tensions within the model by estimating it on subsets of these data. We conclude by pointing out potential extensions that might improve the model’s fit.
Disasters implied by equity index options
, 2009
"... We use prices of equity index options to quantify the impact of extreme events on asset returns. We define extreme events as departures from normality of the log of the pricing kernel and summarize their impact with highorder cumulants: skewness, kurtosis, and so on. We show that highorder cumulan ..."
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Cited by 24 (5 self)
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We use prices of equity index options to quantify the impact of extreme events on asset returns. We define extreme events as departures from normality of the log of the pricing kernel and summarize their impact with highorder cumulants: skewness, kurtosis, and so on. We show that highorder cumulants are quantitatively important in both representativeagent models with disasters and in a statistical pricing model estimated from equity index options. Option prices thus provide independent confirmation of the impact of extreme events on asset returns, but they imply a more modest distribution of them.
Welfare Costs and Long Run Consumption Risk in a Production Economy,”Unpublished paper
, 2006
"... The main goal of this paper is to measure the welfare costs of business cycles in a production economy in which the representative agent has low risk aversion and at the same time the equity premium and the comovements of aggregate quantities and market returns are comparable to what observed in ..."
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Cited by 21 (1 self)
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The main goal of this paper is to measure the welfare costs of business cycles in a production economy in which the representative agent has low risk aversion and at the same time the equity premium and the comovements of aggregate quantities and market returns are comparable to what observed in historical data. In order to do so, I consider a production economy in which the representative agent has EpsteinZinWeil(1989) preferences, productivity has a Long Run Risk component and there are capital adjustment costs. In this way, I try to bridge the gap between the current Long Run Risk asset pricing literature, in which quantities are taken as exogenous, and the standard macroeconomic business cycle models. Preliminary results from a benchmark exchange economy suggest that when there is a Long Run Consumption Risk and the representative agent prefers early resolution of uncertainty, the implied total welfare costs of the consumption uncertainty range from 12 % to
Operating Leverage, Stock Market Cyclicality and the CrossSection of Returns
, 2004
"... I use a puttyclay technology to explain several asset market facts. The key mechanism is as follows: a one percent increase in revenues leads to a morethanone percent increase in profits, since labor costs don’t move oneforone. This amplification is greater for plants with low productivity for ..."
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Cited by 12 (2 self)
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(Show Context)
I use a puttyclay technology to explain several asset market facts. The key mechanism is as follows: a one percent increase in revenues leads to a morethanone percent increase in profits, since labor costs don’t move oneforone. This amplification is greater for plants with low productivity for which the average profit margin (revenue minus costs) is small. This “operating leverage ” effect implies that low productivity plants benefit disproportionately from business cycle booms. These plants have thus higher systematic risk and higher average returns. This model can help explain the empirical findings of Fama and French (1992), and more generally the sources of differences in market betas across firms. I obtain supporting evidence for the mechanism using firm and industrylevel data. The aggregate effect follows from trend growth: lowproductivity plants outnumber highproductivity plants, making the aggregate stock market procyclical. I examine these aggregate implications and find that this model generates a volatile stock market return that predicts the business cycle.
Examining Macroeconomic Models through the Lens of Asset Pricing ∗
, 2011
"... Dynamicstochasticequilibriummodelsofthemacroeconomyaredesignedtomatch the macro time series including impulse response functions. Since these models aim to be structural, they also have implications for asset pricing. To assess these implications, we explore asset pricing counterparts to impulse res ..."
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Cited by 10 (4 self)
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Dynamicstochasticequilibriummodelsofthemacroeconomyaredesignedtomatch the macro time series including impulse response functions. Since these models aim to be structural, they also have implications for asset pricing. To assess these implications, we explore asset pricing counterparts to impulse response functions. We use the resulting dynamic value decomposition (DVD) methods to quantify the exposures of macroeconomic cash flows to shocks over alternative investment horizons and the corresponding prices or compensations that investors must receive because of the exposure to such shocks. We build on the continuoustime methods developed in Hansen and Scheinkman (2010), Borovička et al. (2011) and Hansen (2011) by constructing discretetime shock elasticities that measure the sensitivity of cash flows and their prices to economic shocks including economic shocks featured in the empirical macroeconomics literature. By design, our methods are applicable to economic models that are nonlinear, including models with stochastic volatility. We illustrate our methods by analyzing the asset pricing model of Ai et al. (2010) with tangible and intangible capital.
Sources of entropy in representative agent models
, 2011
"... We propose two performance measures for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The measures describe the pricing kernel’s dispersion (the entropy of the title) and dynamics (horizon dependence, a measure of how entropy varies ..."
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Cited by 9 (3 self)
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We propose two performance measures for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The measures describe the pricing kernel’s dispersion (the entropy of the title) and dynamics (horizon dependence, a measure of how entropy varies over different time horizons). We show how each model generates entropy and horizon dependence, and compare their magnitudes to estimates derived from asset returns. This exercise — and transparent loglinear approximations — clarify the mechanisms underlying these models. It also reveals, in some cases, tension between entropy, which should be large enough to account for observed excess returns, and horizon dependence, which should be small enough to account for mean yield spreads.