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28
What is the maximum return predictability permitted by asset pricing models?", Working Paper
, 2013
"... This paper investigates whether return predictability can be explained by existing asset pricing models. Using different assumptions, I develop two theoretical upper bounds on the Rsquare of the regression of stock returns on predictive variables. Empirically, I find that the predictive Rsquare is ..."
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This paper investigates whether return predictability can be explained by existing asset pricing models. Using different assumptions, I develop two theoretical upper bounds on the Rsquare of the regression of stock returns on predictive variables. Empirically, I find that the predictive Rsquare is significantly larger than the upper bounds, implying that extant asset pricing models are incapable of explaining the degree of return predictability. The reason for this inconsistency is the low correlation between the excess returns and the state variables used in the discount factor. The finding of this paper suggests the development of new asset pricing models with new state variables that are highly correlated with stock returns.
PRELIMINARY AND INCOMPLETE DO NOT CIRCULATE
"... In postwar US data, the market pricedividend ratio has risen up until the end of 2008, while corporate tax rates have slowly fallen. We replicate this negative link in a general equilibrium productionbased asset pricing model with financial frictions where persistent stochastic changes in the cor ..."
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In postwar US data, the market pricedividend ratio has risen up until the end of 2008, while corporate tax rates have slowly fallen. We replicate this negative link in a general equilibrium productionbased asset pricing model with financial frictions where persistent stochastic changes in the corporate tax rate affect longterm productivity. By calibrating a corporate tax process to US data, we find that: 1) firms optimal response to tax shocks induces persistent swings in macroeconomic variables; 2) with recursive preferences these fluctuations strongly affect asset valuations; 3) endogenous leverage and financial frictions amplify the relevance of tax uncertainty.
Credit Risk and Disaster Risk By FRANÇOIS GOURIO ∗
"... 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 fairly safe in ordinary recessions, is exposed to economic depressions, this pa ..."
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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 fairly 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.
RWP 1104Financial Crises, Unconventional Monetary Policy Exit Strategies, and Agents’Expectations ∗
, 2013
"... policy. This paper studies the implications of exit strategies from unconventional monetary Using a Markov switching DSGE model with financial frictions, agents in the model have rational expectations about the probability of financial crises, the probability of an unconventional response to crises, ..."
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policy. This paper studies the implications of exit strategies from unconventional monetary Using a Markov switching DSGE model with financial frictions, agents in the model have rational expectations about the probability of financial crises, the probability of an unconventional response to crises, and the exit strategy used. Selling off assets quickly produces a doubledip recession; in contrast, a slow unwind generates a smooth recovery. Expectations about the exit strategy matter for the initial effectiveness of intervention. Increasing the probability of an unconventional response to crises creates distortions in The views expressed herein are solely those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System. I thank Juan RubioRamirez, Francesco
Web: www.kellogg.northwestern.edu/faculty/muir/
, 2013
"... The literature on rare disasters shows that low probability events can explain high, timevarying risk premia. I find that large spikes in risk premia occur around financial crises but not around other disasters such as wars. A model with financial intermediaries generates endogenous financial crise ..."
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The literature on rare disasters shows that low probability events can explain high, timevarying risk premia. I find that large spikes in risk premia occur around financial crises but not around other disasters such as wars. A model with financial intermediaries generates endogenous financial crises that quantitatively match those in the data, while also replicating high equity risk premia and volatility. Compared to a standard disasters framework, the model makes additional empirical predictions which I confirm in the data. First, the equity of the intermediary sector strongly forecasts stock returns. Second, financial crises are temporary, which implies that the term structure of risky assets is downward sloping during financial crises when risk premia are concentrated in the near term. The model explains the level and slope of the term structure of risky assets including equities, corporate bonds, and VIX, both unconditionally and in a crisis. I then use the term structure of risky assets to infer the daily probability and persistence of a financial crisis in real time, providing a useful tool to analyze policy responses in a crisis.
The Financing of Ideas and the Great Deviation Job Market Paper Most recent version available at: stanford.edu/∼dgarciam/jmp_garcia_macia.pdf
, 2015
"... Why did the Great Recession lead to such a slow recovery? I build a model where heterogeneous firms invest in physical and in intangible capital, and can default on their debt. In case of default, intangible assets are harder to seize by external investors. Hence, financing intangible capital faces ..."
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Why did the Great Recession lead to such a slow recovery? I build a model where heterogeneous firms invest in physical and in intangible capital, and can default on their debt. In case of default, intangible assets are harder to seize by external investors. Hence, financing intangible capital faces higher costs than financing physical capital. This differential is exacerbated in a financial crisis, when default is more likely and aggregate risk bears a higher premium. The resulting fall in intangible investment amplifies the financial crisis, and gradual intangible capital spillovers to other firms contribute to its persistence. Using a rich panel dataset of Spanish manufacturing firms, I estimate the model by matching firmlevel moments regarding physical and intangible investment and financing. The model captures the extent and components of the Great Recession, as incumbent intangible investment falls and firm exit rates surge. A standard model without endogenous intangible investment would miss half of the 20082013 GDP fall in Spanish manufacturing. Targeted fiscal policy could speed up the recovery: transfers to young firms relax the borrowing constraints of the firms
Disaster Risk and Preference Shifts in a New Keynesian Model
, 2015
"... A timevarying probability of ‘disaster ’ is sufficient to generate a recession and an increase in risk premia in the literature. However, this result critically relies on the value of the elasticity of intertemporal substitution (EIS). Indeed, when the EIS is smaller than unity, the agents choose t ..."
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A timevarying probability of ‘disaster ’ is sufficient to generate a recession and an increase in risk premia in the literature. However, this result critically relies on the value of the elasticity of intertemporal substitution (EIS). Indeed, when the EIS is smaller than unity, the agents choose to save and invest more. In a real business cycle model, an increase in disaster risk thus creates a boom. The New Keynesian structure allows to conciliate the recessionary effects of disaster risk with a plausible value of the EIS through the sluggishness in price adjustments. The model then generates recession and deflation, as well as a decrease in consumption, investment and wages, in line with the preference shock literature, while it preserves the countercyclicality of risk premia.
Unemployment and Credit Risk
, 2015
"... Corporate bond yields are sensitive to labor market conditions. During the 19292015 period, a one percentage point increase in the unemployment rate is associated with a widening of the BaaAaa credit spread by 13 basis points. This paper explores the impact of labor market conditions on credit ris ..."
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Corporate bond yields are sensitive to labor market conditions. During the 19292015 period, a one percentage point increase in the unemployment rate is associated with a widening of the BaaAaa credit spread by 13 basis points. This paper explores the impact of labor market conditions on credit risk, by incorporating defaultable debt into an otherwise standard DiamondMortensenPissarides labor search framework. A reasonably calibrated model quantitatively accounts for the strong response of credit spreads to unemployment, in addition to other salient features of credit spreads. In the model, the possibility of default renders corporate bond prices (and credit spreads) sensitive to the variation in the asset value of employment relationships, driven by labor market conditions.
Microeconomic Origins of Macroeconomic Tail Risks
, 2014
"... We document that even though the normal distribution is a good approximation to the nature of aggregate fluctuations, it severely underpredicts the frequency of large economic downturns. We then provide a model that can explain these facts simultaneously. Our model shows that the propagation of mic ..."
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We document that even though the normal distribution is a good approximation to the nature of aggregate fluctuations, it severely underpredicts the frequency of large economic downturns. We then provide a model that can explain these facts simultaneously. Our model shows that the propagation of microeconomic shocks through inputoutput linkages can fundamentally reshape the distribution of aggregate output, increasing the likelihood of large downturns (macroeconomic tail risks) from infinitesimal to substantial. For example, an economy subject to thintailed micro shocks but with “unbalanced” inputoutput linkages (where some sectors or firms play a much more important role than others as inputs suppliers to the rest of the economy) may exhibit deep recessions as frequently as economies that are subject to heavytailed shocks. This is despite the fact that a central limit theoremtype result would imply that aggregate output is normally distributed. We characterize what types of inputoutput linkages and distributions of microeconomic shocks lead to sizable macroeconomic tail risks, and also show how the same economic forces cause the output of many sectors to simultaneously fall by large amounts.