Asset pricing, habit memory, and the labor market

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This paper develops a new utility specification that incorporates Campbell—Cochrane—type habits into the Epstein—Zin class of preferences. In a simple calibration of a real business cycle model with EZ-habit preferences, the model generates a strongly countercyclical equity premium, substantial equity return predictability, and a stable riskless interest rate, as in the data. Moreover, conditional on the average level of risk aversion, time-variation in risk aversion increases the volatility and mean return of equities. On the real side, the model matches the short and long-term variances of output, consumption, and investment growth. As an additional empirical test, I measure implied risk aversion and find that it has an R2 of over 50 percent for 5-year stock returns in post-war data. Variables that predict stock returns in the data also predict returns in the model with a similar degree of explanatory power. 1

We study the role of contract enforcement in shaping the dynamics of international trade at the firm level. We develop a theoretical model to describe how agents build reputations to overcome the problems created by weak enforcement of international contracts. We find that, all else equal, exporters start their activities with higher volumes and remain as exporters for a longer period in countries with better contracting institutions. However, conditional on survival, the growth rate of a firm’s exports to a country decreases with the quality of the country’s institutions. We test these predictions using a rich panel of Belgium exporting firms from 1995 to 2008 to every country in the world. We adopt two alternative empirical strategies. In one specification we use firm-year fixed effects to control for time-varying firm-specific characteristics. Alternatively, we model selection more explicitly with a two-step Heckman procedure using “extended gravity ” variables as our exclusion restrictions. Results from both specifications support our predictions. Overall, our findings suggest that weak contracting institutions cannot be thought simply as an extra sunk or fixed cost to exporting firms; they also significantly affect firms ’ trade volumes and have manifold implications for