Results 11  20
of
89
Option prices in a model with stochastic disaster risk ∗ Sang Byung Seo
, 2013
"... In a challenge to models that link the equity premium to rare disasters, Backus, Chernov, and Martin (2011) show that data on options imply negative events that are far smaller than these models suggest. We show that this result depends critically on the assumption that the probability of the rare e ..."
Abstract

Cited by 7 (2 self)
 Add to MetaCart
In a challenge to models that link the equity premium to rare disasters, Backus, Chernov, and Martin (2011) show that data on options imply negative events that are far smaller than these models suggest. We show that this result depends critically on the assumption that the probability of the rare event is constant. That is, a model with stochastic jumps in consumption can simultaneously explain options data and the equity premium. Indeed, such a model delivers an excellent fit to implied volatilities, despite being calibrated to match the equity premium and equity volatility alone.
Expectations of Returns and Expected Returns *
, 2013
"... We analyze timeseries of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor ..."
Abstract

Cited by 5 (0 self)
 Add to MetaCart
We analyze timeseries of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with modelbased expected returns. We reconcile the evidence by calibrating a simple behavioral model, in which fundamental traders require a premium to accommodate expectations shocks from extrapolative traders, but markets are not efficient.
Rare booms and disasters in a multisector endowment economy
, 2013
"... Why do value stocks have higher expected returns than growth stocks, in spite of having lower risk? Why do these stocks exhibit positive abnormal performance while growth stocks exhibit negative abnormal performance? This paper offers a rareevents based explanation, that can also account for facts a ..."
Abstract

Cited by 5 (2 self)
 Add to MetaCart
Why do value stocks have higher expected returns than growth stocks, in spite of having lower risk? Why do these stocks exhibit positive abnormal performance while growth stocks exhibit negative abnormal performance? This paper offers a rareevents based explanation, that can also account for facts about the aggregate market. Patterns in timeseries predictability offer independent evidence for the model’s conclusions.
Risk Premia and the Conditional Tails of Stock Returns
, 2009
"... Theory suggests that the risk of infrequent yet extreme events has a large impact on asset prices. Testing models of this hypothesis remains a challenge due to the difficulty of measuring tail risk fluctuations over time. I propose a new measure of timevarying tail risk that is motivated by asset p ..."
Abstract

Cited by 5 (0 self)
 Add to MetaCart
Theory suggests that the risk of infrequent yet extreme events has a large impact on asset prices. Testing models of this hypothesis remains a challenge due to the difficulty of measuring tail risk fluctuations over time. I propose a new measure of timevarying tail risk that is motivated by asset pricing theory and is directly estimable from the cross section of returns. My procedure applies Hill’s (1975) tail risk estimator to the cross section of extreme events each day. It then optimally averages recent crosssectional Hill estimates to provide conditional tail risk forecasts. Empirically, my measure has strong predictive power for aggregate market returns, outperforming all commonly studied predictor variables. I find that a one standard deviation increase in tail risk forecasts an increase in excess market returns of 4.4 % over the following year. Crosssectionally, stocks that highly positively covary with my tail risk measure earn average annual returns 6.0 % lower than stocks with low tail risk covariation. I show that these results are consistent with predictions from two structural models: i) a long run risks economy with heavytailed consumption and dividend growth shocks, and ii) a timevarying rare disaster framework.
Disaster begets crisis: The role of contagion in financial markets, working paper
, 2011
"... Severe economic downturns like the great depression of the 1930s take place over extended periods of time. I model an economy where rare economic disasters increase the likelihood of subsequent near term disasters. The mechanism generates more clustering of disasters than existing models. Serial cor ..."
Abstract

Cited by 5 (0 self)
 Add to MetaCart
Severe economic downturns like the great depression of the 1930s take place over extended periods of time. I model an economy where rare economic disasters increase the likelihood of subsequent near term disasters. The mechanism generates more clustering of disasters than existing models. Serial correlation in disasters has important implications for asset prices. For example, it generates a larger equity premium and a lower risk free rate than similarly calibrated models without this feature. The calibrated model developed here replicates the temporal structure of severe economic downturns in OECD countries. It quantitatively explains the equity premium, the riskfree rate, excess volatility and return predictability. It also generates the implied volatility smile observed in equity index options. I want to thank my dissertation committee Mark Grinblatt (chair), Antonio Bernardo, Hanno Lustig,
Asset Pricing with Countercyclical Household Consumption Risk
, 2014
"... We present evidence that shocks to household consumption growth are negatively skewed, persistent, and countercyclical and play a major role in driving asset prices. We construct a parsimonious model with one state variable that drives the conditional crosssectional moments of household consumption ..."
Abstract

Cited by 5 (1 self)
 Add to MetaCart
We present evidence that shocks to household consumption growth are negatively skewed, persistent, and countercyclical and play a major role in driving asset prices. We construct a parsimonious model with one state variable that drives the conditional crosssectional moments of household consumption growth. The estimated model provides a good fit for the moments of the crosssectional distribution of household consumption growth and the unconditional moments of the risk free rate, equity premium, market pricedividend ratio, and aggregate dividend and consumption growth. The explanatory power of the model does not derive from possible predictability of aggregate dividend and consumption growth as these are intentionally modeled as i.i.d. processes. Consistent with empirical evidence, the model implies that the risk free rate and pricedividend ratio are procyclical while the expected market return and the variance of the market return and risk free rate are countercyclical. Household consumption risk also explains the crosssection of excess returns.
Rare Events, Financial Crises, and the CrossSection of Asset Returns
, 2008
"... This paper shows that rare events are useful in explaining the cross section of asset returns because they are important in shaping agentsexpectations. I reconsider the "bad beta, good beta " ICAPM and I point out that the explanatory power of the model depends on including the stock marke ..."
Abstract

Cited by 4 (1 self)
 Add to MetaCart
This paper shows that rare events are useful in explaining the cross section of asset returns because they are important in shaping agentsexpectations. I reconsider the "bad beta, good beta " ICAPM and I point out that the explanatory power of the model depends on including the stock market crash that opened the Great Depression. When using a Markovswitching VAR, a 30s regime is identi
ed. This regime receives a large weight when forming expectations consistent with the ICAPM. I then generalize this result showing that
nancial variables behave in a substantially di¤erent way during a crisis. Accordingly, the ICAPM delivers excellent results when investors distinguish between a high and a lowuncertainty regime. As a technical contribution, I describe how to estimate a Markovswitching VAR in reduced form. I am grateful to Chris Sims for useful suggestions at the early stage of this work. I thank Robert Barro,
Credit Risk and Disaster Risk
, 2012
"... Credit spreads are large, volatile and countercyclical, and recent empirical work suggests that risk premia, not expected credit losses, are responsible for these features. Building on the idea that corporate debt, while safe in ordinary recessions, is exposed to economic depressions, this paper emb ..."
Abstract

Cited by 4 (0 self)
 Add to MetaCart
Credit spreads are large, volatile and countercyclical, and recent empirical work suggests that risk premia, not expected credit losses, are responsible for these features. Building on the idea that corporate debt, while safe in ordinary recessions, is exposed to economic depressions, this paper embeds a tradeoff theory of capital structure into a real business cycle model with a small, exogenously timevarying risk of economic disaster. The model replicates the level, volatility and cyclicality of credit spreads, and variation in the corporate bond risk premium amplifies macroeconomic fluctuations in investment, employment and GDP.
Asset Allocation
 Annual Reviews of Financial Economics
, 2010
"... This review article describes recent literature on asset allocation, covering both static and dynamic models. The article focuses on the bond–stock decision and on the implications of return predictability. In the static setting, investors are assumed to be Bayesian, and the role of various prior be ..."
Abstract

Cited by 3 (1 self)
 Add to MetaCart
This review article describes recent literature on asset allocation, covering both static and dynamic models. The article focuses on the bond–stock decision and on the implications of return predictability. In the static setting, investors are assumed to be Bayesian, and the role of various prior beliefs and specifications of the likelihood are explored. In the dynamic setting, recursive utility is assumed, and attention is paid to obtaining analytical results when possible. Results under both full and limitedinformation assumptions are discussed.
Measuring the “Dark Matter ” in Asset Pricing Models
, 2013
"... Models of rational expectations endow agents with precise knowledge of the probability laws inside the models. This assumption becomes more tenuous when a model’s performance is highly sensitive to the parameters that are difficult to estimate directly, i.e., when a model relies on “dark matter. ” W ..."
Abstract

Cited by 3 (0 self)
 Add to MetaCart
Models of rational expectations endow agents with precise knowledge of the probability laws inside the models. This assumption becomes more tenuous when a model’s performance is highly sensitive to the parameters that are difficult to estimate directly, i.e., when a model relies on “dark matter. ” We propose new measures of model fragility by quantifying the informational burden that a rational expectations model places on the agents. By measuring the informativeness of the crossequation restrictions implied by a model, our measures can systematically detect the direction in the parameter space in which the model’s performance is the most fragile. Our methodology provides new ways to conduct sensitivity analysis on quantitative models. It helps identify situations where parameter or model uncertainty cannot be ignored. It also helps with evaluating competing classes of models that try to explain the same set of empirical phenomena from the perspective of the robustness of their implications.