We empirically analyze the pricing of political uncertainty, guided by a the-oretical model of government policy choice. To isolate political uncertainty, we exploit its variation around major political events, namely, national elections and global summits. We find that political uncertainty is priced in the equity option market in ways predicted by the theory. Options whose lives span political events tend to be more expensive. Such options provide valuable protection against the risk associated with political events, including not only price risk but also vari-ance and tail risks. This protection is more valuable in a weaker economy as well as amid higher political uncertainty.

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.

This paper studies the asset pricing implications of Bayesian learning about the parameters, states, and models determining aggregate consumption dynamics. Our approach is empirical and focuses on the quantitative implications of learning in real-time using post World War II consumption data. We characterize this learning process and provide empirical evidence that revisions in beliefs stemming from parameter and model uncertainty are signi…cantly related to realized aggregate equity returns. Further, we show that beliefs regarding the conditional moments of consumption growth are strongly time-varying and exhibit business cycle and/or long-run ‡uctuations. Much of the long-run behavior is unanticipated ex ante. We embed these subjective beliefs in a general equilibrium model and …nd that about half of the post World-War II observed equity market risk premium and much of the observed return predictability are due to unexpected revisions in beliefs about parameters and models governing consumption dynamics.

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 cross-sectional moments of household consumption growth. The estimated model provides a good fit for the moments of the cross-sectional distribution of household consumption growth and the unconditional moments of the risk free rate, equity premium, market price-dividend 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 price-dividend ratio are pro-cyclical while the expected market return and the variance of the market return and risk free rate are countercyclical. Household consumption risk also explains the cross-section of excess returns.

Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

Abstract. This paper introduces new econometric tools for studying the long-run implications of dynamic asset pricing models. The long-run implications of a model are jointly determined by the functional form of the SDF and the dynamic behavior of the variables in the model. The estimators introduced in this paper treat the dynamics as an unknown nuisance parameter. Nonparametric sieve estimators of the positive eigenfunction and eigenvalue used to decompose the stochastic dis-count factor (SDF) into its permanent and transitory components are proposed, as are estimators of the long-term yield and entropy of the permanent component of the SDF. The estimators are par-ticularly simple to implement, and may be used to numerically compute the long-run implications of fully specified models for which analytical solutions are unavailable. Nonparametric identification conditions are presented. Consistency and convergence rates of the estimators are established. An approach for conducting asymptotic inference on the eigenvalue, long-term yield, and entropy of the permanent component of the SDF is provided. The semiparametric efficiency bounds for these parameters are derived and their estimators are shown to be efficient. The long-run implications of the consumption CAPM are investigated using these methods. The estimators, identification conditions, and large sample theory presented in this paper have broader application in economics

The Harvard Environmental Economics Program The Harvard Environmental Economics Program (HEEP) develops innovative answers to today’s complex environmental issues, by providing a venue to bring together faculty and graduate students from across Harvard University engaged in research, teaching, and outreach in environmental and natural resource economics and related public policy. The program sponsors research projects, convenes workshops, and supports graduate education to further understanding of critical issues in environmental, natural resource, and energy economics and policy around the world.

We use cross-sectional information on the prices of G10 currency options to calibrate a non-Gaussian model of pricing kernel dynamics and construct estimates of conditional currency risk premia. We find that the mean historical returns to short dollar and carry factors (HMLFX) are statistically indistinguishable from their option-implied counterparts, which are free from peso problems. Skewness and higher-order moments of the pricing kernel innovations on average account for only 15 % of the HMLFX risk premium in G10 currencies. These results are consistent with the observation that crash-hedged currency carry trades continue to deliver positive excess returns.

We analyze the effects of the observed increased share of delegated capital for trading strategies and equilibrium prices by introducing delegation into a standard Lucas exchange economy. In equilibrium, some investors trade on their own account, but others decide to delegate trading to professional fund managers. Flow-performance incentive functions describe how much capital clients provide to funds at each date as a function of past performance. Convex flow-performance relations imply that the average fund outperforms the market in recessions and underperforms in expansions. When the share of capital that is delegated is low, all funds follow the same strategy. However, when the equilibrium share of delegated capital is high, funds with identical incentives employ heterogeneous trading strategies. A group of managers borrows to take on a levered position on the stock. Thus, fund returns are dispersed in the cross-section and the outstanding amounts of borrowing and lending increase. The relation between the share of delegated capital and the Sharpe ratio typically follows an inverse U-shaped pattern. (JEL G11, G12, G23, D02, D81) Over the past thirty years, there has been a gradual but profound change in the way money is invested in financial markets. While almost 50 % of U.S. equities

We explore the term structures of claims to a variety of cash flows: US government bonds (claims to dollars), foreign government bonds (claims to foreign currency), inflation-adjusted bonds (claims to the price index), and equity (claims to future equity indexes or dividends). Average term structures reflect the dynamics of the dollar pricing kernel, of cash flow growth, and of their interaction. We use simple models to illustrate how relations between the two components can deliver term structures with a wide range of levels and shapes.