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328
Consumption Strikes Back?: Measuring Long Run Risk, Unpublished working paper
, 2006
"... 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 110 (13 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. I.
Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in MacroFinance. Unpublished working paper
, 2010
"... This paper incorporates a timevarying severity of disasters into the hypothesis proposed by Rietz (1988) and Barro (2006) that risk premia result from the possibility of rare large disasters. During a disaster an asset’s fundamental value falls by a timevarying amount. This in turn generates time ..."
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Cited by 74 (5 self)
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This paper incorporates a timevarying severity of disasters into the hypothesis proposed by Rietz (1988) and Barro (2006) that risk premia result from the possibility of rare large disasters. During a disaster an asset’s fundamental value falls by a timevarying amount. This in turn generates timevarying risk premia and thus volatile asset prices and return predictability. Using the recent technique of linearitygenerating processes, the model is tractable and all prices are exactly solved in closed form. In this paper’s framework, the following empirical regularities can be understood quantitatively: (i) equity premium puzzle; (ii) riskfree rate puzzle; (iii) excess volatility puzzle; (iv) predictability of aggregate stock market returns with pricedividend ratios; (v) often greater explanatory power of characteristics than covariances for asset returns; (vi) upward sloping nominal yield curve; (vii) predictability of future bond excess returns and long term rates via the slope of the yield curve; (viii) corporate bond spread puzzle; (ix) high price of deep outofthemoney puts; and (x) high put prices being followed by high stock returns. The calibration passes a variance bound test, as normaltimes market volatility is consistent with the wide dispersion of disaster outcomes in the historical record. The model also extends to EpsteinZinWeil preferences and to a setting with many factors.
On the relationship between the conditional mean and volatility of stock returns: A latent VAR approach
, 2002
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The Declining Equity Premium: What Role Does Macroeconomic Risk Play?
 THE REVIEW OF FINANCIAL STUDIES
, 2006
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Why is longhorizon equity less risky? A durationbased explanation of the value premium, NBER working paper
, 2005
"... We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model im ..."
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Cited by 50 (10 self)
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We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model implies that growth firms covary more with the discount rate than do value firms, which covary more with cash flows. When calibrated to explain aggregate stock market behavior, the model accounts for the observed value premium, the high Sharpe ratios on value firms, and the poor performance of the CAPM. THIS PAPER PROPOSES A DYNAMIC RISKBASED MODEL that captures both the high expected returns on value stocks relative to growth stocks, and the failure of the capital asset pricing model to explain these expected returns. The value premium, first noted by Graham and Dodd (1934), is the finding that assets with a high ratio of price to fundamentals (growth stocks) have low expected returns relative to assets with a low ratio of price to fundamentals (value stocks). This
Agentbased computational finance
 in Handbook of Computational Economics, Agentbased Computational Economics
, 2006
"... This paper surveys research on computational agentbased models used in finance. It will concentrate on models where the use of computational tools is critical in the process of crafting models which give insights into the importance and dynamics of investor heterogeneity in many financial settings. ..."
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Cited by 46 (2 self)
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This paper surveys research on computational agentbased models used in finance. It will concentrate on models where the use of computational tools is critical in the process of crafting models which give insights into the importance and dynamics of investor heterogeneity in many financial settings.
Macroeconomic conditions and the puzzles of credit spreads and capital structure
, 2008
"... Investors demand high risk premia for defaultable claims, because (i) defaults tend to concentrate in bad times when marginal utility is high; (ii) default losses are high during such times. I build a structural model of financing and default decisions in an economy with businesscycle variations in ..."
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Cited by 45 (3 self)
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Investors demand high risk premia for defaultable claims, because (i) defaults tend to concentrate in bad times when marginal utility is high; (ii) default losses are high during such times. I build a structural model of financing and default decisions in an economy with businesscycle variations in expected growth rates and volatility, which endogenously generate countercyclical comovements in risk prices, default probabilities, and default losses. Credit risk premia in the calibrated model not only can quantitatively account for the high corporate bond yield spreads and low leverage ratios in the data, but have rich implications for firms’ financing decisions.
The Bond Premium in a DSGE Model with LongRun Real and Nominal Risks
, 2009
"... The term premium on nominal longterm bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data — an example of the “bond premium puzzle.” However, in models of endowment economie ..."
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Cited by 39 (9 self)
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The term premium on nominal longterm bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data — an example of the “bond premium puzzle.” However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors have recursive EpsteinZin preferences and face longrun economic risks. We show that introducing EpsteinZin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model’s ability to fit key macroeconomic variables. Longrun real and nominal risks further improve the model’s ability to fit the data with a lower level of household risk aversion.
Rare Disasters, Asset Prices and Welfare Costs. American Economic Review, forthcoming
, 2009
"... A representativeconsumer model with EpsteinZinWeil preferences and i.i.d. shocks, including rare disasters, accords with observed equity premia and riskfree rates if the coefficient of relative risk aversion equals 3–4. If the intertemporal elasticity of substitution exceeds one, an increase in ..."
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Cited by 36 (0 self)
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A representativeconsumer model with EpsteinZinWeil preferences and i.i.d. shocks, including rare disasters, accords with observed equity premia and riskfree rates if the coefficient of relative risk aversion equals 3–4. If the intertemporal elasticity of substitution exceeds one, an increase in uncertainty lowers the pricedividend ratio for equity, and a rise in the expected growth rate raises this ratio. Calibrations indicate that society would willingly reduce GDP by around 20 percent each year to eliminate rare disasters. The welfare cost from usual economic fluctuations is much smaller, though still important, corresponding to lowering GDP by about 1.5 percent each year. (JEL E13, E21, E22, E32) In a previous study, Barro (2006), I used the Thomas A. Rietz (1988) idea of rare economic disasters to explain the equity premium and related assetpricing puzzles. My quantitative examination of large macroeconomic contractions in 35 countries during the twentieth century suggested a disaster probability of roughly 2 percent per year. The size distribution of GDP contractions during these events ranged between 15 percent (the arbitrary lower bound) and over 60
HabitBased Explanation of the Exchange Rate Risk Premium
, 2005
"... This paper presents a fully rational general equilibrium model that produces a timevarying exchange rate risk premium and solves the uncovered interest rate parity (U.I.P) puzzle. In this twocountry model, agents are characterized by slowmoving external habit preferences derived from Campbell & Co ..."
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Cited by 35 (5 self)
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This paper presents a fully rational general equilibrium model that produces a timevarying exchange rate risk premium and solves the uncovered interest rate parity (U.I.P) puzzle. In this twocountry model, agents are characterized by slowmoving external habit preferences derived from Campbell & Cochrane (1999). Endowment shocks are i.i.d and real riskfree rates are timevarying. Agents can trade across countries, but when a unit is shipped, only a fraction of the good arrives to the foreign shore. The model gives a rationale for the U.I.P puzzle: the domestic investor receives a positive exchange rate risk premium when she is more riskaverse than her foreign counterpart. Times of high riskaversion correspond to low interest rates. Thus, the domestic investor receives a positive risk premium when interest rates are lower at home than abroad. The model is both simulated and estimated. The simulation recovers the usual negative coefficient between exchange rate variations and interest rate differentials. When the iceberglike trade cost is taken into account, the exchange rate variance produced is in line with its empirical counterpart. A nonlinear estimation of the model using consumption data leads to reasonable parameters when pricing the foreign excess returns of an American investor.