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40
A ConsumptionBased Model of the Term Structure of Interest Rates
, 2004
"... This paper proposes a consumptionbased model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a timevarying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expec ..."
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Cited by 71 (4 self)
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This paper proposes a consumptionbased model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a timevarying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expected inflation. When calibrated to data on consumption, inflation, and the average level of bond yields, the model produces realistic volatility of bond yields and can explain key aspects of the expectations puzzle documented by Campbell and Shiller (1991) and Fama and Bliss (1987). When actual consumption and inflation data are fed into the model, the model is shown to account for many of the short and longrun fluctuations in the shortterm interest rate and the yield spread. At the same time, the model captures the high equity premium and
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
Financial Markets and the Real Economy
, 2006
"... I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” ..."
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Cited by 19 (1 self)
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I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” I survey the literature, covering the timeseries and crosssectional facts, the equity premium, consumptionbased models, general equilibrium models, and labor income/idiosyncratic risk approaches.
The Term Structures of Equity and Interest Rates
, 2007
"... This paper proposes a dynamic riskbased model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks conv ..."
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Cited by 15 (1 self)
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This paper proposes a dynamic riskbased model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks convey information about how the representative investor values cash flows of different maturities. We model how the representative investor perceives risks of these cash flows by specifying a parsimonious stochastic discount factor for the economy. Shocks to dividend growth, the real interest rate, and expected inflation are priced, but shocks to the price of risk are not. Given reasonable assumptions for dividends and inflation, we show that the model can simultaneously account for the behavior of aggregate stock returns, an upwardsloping yield curve, the failure of the expectations hypothesis and the poor performance of the capital asset pricing model.
A Skeptical Appraisal of AssetPricing Tests
 Journal of Financial Economics
, 2010
"... Polk, Motohiro Yogo, an anonymous referee, and workshop participants at numerous universities and conferences for their helpful comments. We thank Ken French, Sydney Ludvigson, Stijn Van Nieuwerburgh, and Motohiro Yogo for providing data via their websites. A Skeptical Appraisal of AssetPricing Tes ..."
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Cited by 15 (2 self)
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Polk, Motohiro Yogo, an anonymous referee, and workshop participants at numerous universities and conferences for their helpful comments. We thank Ken French, Sydney Ludvigson, Stijn Van Nieuwerburgh, and Motohiro Yogo for providing data via their websites. A Skeptical Appraisal of AssetPricing Tests It has become standard practice in the crosssectional assetpricing literature to evaluate models based on how well they explain average returns on sizeB/M portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that assetpricing tests are often highly misleading, in the sense that apparently strong explanatory power (high crosssectional R 2 s and small pricing errors) in fact provides quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models don’t work as well as originally advertised
Is Accruals Quality a Priced Risk Factor?
, 2006
"... Schipper, two anonymous referees, and seminar participants at the Wharton School, and gratefully acknowledge the financial support of the Wharton School. Rodrigo Verdi is also grateful for financial In an influential recent empirical paper, Francis, LaFond, Olsson, and Schipper (FLOS, Journal of Acc ..."
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Cited by 11 (0 self)
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Schipper, two anonymous referees, and seminar participants at the Wharton School, and gratefully acknowledge the financial support of the Wharton School. Rodrigo Verdi is also grateful for financial In an influential recent empirical paper, Francis, LaFond, Olsson, and Schipper (FLOS, Journal of Accounting and Economics 2005) conclude that accruals quality (AQ) is a priced risk factor. Such a claim is important to understand given that there is no consensus in current theory that accounting quality or information risk is priced, and that more recent papers question earlier claims that information risk is not diversifiable. FLOS base their inference, in part, on results from timeseries regressions of contemporaneous stock returns on returns to portfolios that mimic exposure to AQ, the market, size, and booktomarket. We show that FLOS ’ tests of a contemporaneous relation between excess returns and factor returns do not test the hypothesis that AQ is a priced risk factor. We conduct wellspecified asset pricing tests for determining whether a potential risk factor explains expected returns, and find no evidence that AQ is a priced risk factor. While evidence from other types of tests, such as the implied costofcapital tests in Francis, LaFond, Olsson, and Schipper (The Accounting Review 2004), show that firms with higher accounting quality have lower implied costofcapital, it is important for researchers to know that traditional asset pricing tests provide no support for this hypothesis.
Yield Curve Predictors of Foreign Exchange Returns ∗
, 2010
"... uncovered interest rate parity We thank Rudy LooKung for some research assistance work. We especially thank Bob Hodrick ..."
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Cited by 9 (0 self)
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uncovered interest rate parity We thank Rudy LooKung for some research assistance work. We especially thank Bob Hodrick
2003, Risk and Valuation under an Intertemporal Capital Asset Pricing Model, Working Paper
"... We analyze the risk characteristics and the valuation of assets in an economy in which the investment opportunity set is described by the real interest rate and the maximum Sharpe ratio. It is shown that, holding constant the beta of the underlying cash flow, the beta of a security is a function of ..."
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Cited by 9 (1 self)
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We analyze the risk characteristics and the valuation of assets in an economy in which the investment opportunity set is described by the real interest rate and the maximum Sharpe ratio. It is shown that, holding constant the beta of the underlying cash flow, the beta of a security is a function of the maturity of the cash flow. For parameter values estimated from U.S. data, the security beta is always increasing with the maturity of the underlying cash flow, while discount rates for risky cash flows can be increasing, decreasing or nonmonotone functions of the maturity of the cash flow. The variation in discount rates and present value factors that is due to variation in the real interest rate and the Sharpe ratio is shown to be large for long maturity cash flows, and the component of the volatility that is due to variation in the Sharpe ratio Despite the terminology, neither the single period Capital Asset Pricing Model, 1 nor its intertemporal version (Merton, 1973), actually prices capital assets; rather, these models provide necessary conditions between the expected rates of change in asset prices and the