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1,780
Equity volatility and corporate bond yields
 Journal of Finance
, 2003
"... This paper explores the e¡ect of equity volatility on corporate bond yields. Panel data for the late 1990s show that idiosyncratic ¢rmlevel volatility can explain as much crosssectional variation in yields as can credit ratings. This ¢nding, together with the upward trend in idiosyncratic equity v ..."
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Cited by 158 (1 self)
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This paper explores the e¡ect of equity volatility on corporate bond yields. Panel data for the late 1990s show that idiosyncratic ¢rmlevel volatility can explain as much crosssectional variation in yields as can credit ratings. This ¢nding, together with the upward trend in idiosyncratic equity volatility documented by Campbell, Lettau, Malkiel, and Xu (2001), helps to explain recent increases in corporate bond yields. DURING THE LATE 1990s, THE U.S. EQUITY and corporate bond markets behaved very di¡erently. As displayed in Figure 1, stock prices rose strongly, while at the same time, corporate bonds performed poorly. The proximate cause of the low returns on corporate bonds was a tendency for the yields on both seasoned and newly issued corporate bonds to increase relative to the yields of U.S.Treasury securities. These increases in corporate^Treasury yield spreads are striking because they occurred at a time when stock prices were rising; the optimism of stock market investors did not seem to be shared by investors in the corporate bond market.
New Evidence on the Interest Rate Effects of Budget Deficits and Debt
 Journal of the European Economic Association
, 2009
"... Estimating the effects of government debt and deficits on Treasury yields is complicated from the effects of the business cycle, and associated monetary policy actions, on debt, deficits, and interest rates, this paper studies the relationship between longhorizon expected government debt and defici ..."
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Cited by 156 (1 self)
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Estimating the effects of government debt and deficits on Treasury yields is complicated from the effects of the business cycle, and associated monetary policy actions, on debt, deficits, and interest rates, this paper studies the relationship between longhorizon expected government debt and deficits, measured by CBO and OMB projections, and expected future longterm interest rates. The estimated effects of government debt and deficits on interest rates are statistically and economically significant: a one percentage point increase in the projected deficittoGDP ratio is estimated to raise longterm interest rates by roughly 25 basis points. Under plausible assumptions these estimates are shown to be consistent with predictions of the neoclassical growth model. JEL classification: E6, H6.
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 147 (9 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.
Understanding Predictability
 JOURNAL OF POITICAL ECONOMY
, 2004
"... We propose a general equilibrium model with multiple securities in which investors’ risk preferences and expectations of dividend growth are time varying. While time varying risk preferences induce the standard positive relation between the dividend yield and expected returns, time varying expected ..."
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Cited by 143 (8 self)
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We propose a general equilibrium model with multiple securities in which investors’ risk preferences and expectations of dividend growth are time varying. While time varying risk preferences induce the standard positive relation between the dividend yield and expected returns, time varying expected dividend growth induces a negative relation between them. These offsetting effects reduce the ability of the dividend yield to forecast returns and eliminate its ability to forecast dividend growth, as observed in the data. The model links the predictability of returns to that of dividend growth, suggesting specific changes to standard linear predictive regressions for both. The model’s predictions are con…rmed empirically.
Is All That Talk Just Noise ? The Information Content of Internet Stock Message Boards
 Journal of Finance
, 2004
"... Financial press reports claim that internet stock message boards can move markets. We study the effect of more than 1.5 million messages posted on Yahoo! Finance and Raging Bull about the 45 companies in the Dow Jones Industrial Average, and the Dow Jones Internet Index. The bullishness of the messa ..."
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Cited by 135 (2 self)
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Financial press reports claim that internet stock message boards can move markets. We study the effect of more than 1.5 million messages posted on Yahoo! Finance and Raging Bull about the 45 companies in the Dow Jones Industrial Average, and the Dow Jones Internet Index. The bullishness of the messages is measured using computational linguistics methods. News stories reported in the Wall Street Journal are used as controls. We find significant evidence that the stock messages help predict market volatility, but not stock returns. Consistent with Harris and Raviv (1993), agreement among the posted messages is associated with decreased trading volume. (JEL: G12, G14)
There is a riskreturn tradeoff after all
, 2004
"... This paper studies the intertemporal relation between the conditional mean and the conditional variance of the aggregate stock market return. We introduce a new estimator that forecasts monthly variance with past daily squared returns, the mixed data sampling (or MIDAS) approach. Using MIDAS, we fin ..."
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Cited by 133 (24 self)
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This paper studies the intertemporal relation between the conditional mean and the conditional variance of the aggregate stock market return. We introduce a new estimator that forecasts monthly variance with past daily squared returns, the mixed data sampling (or MIDAS) approach. Using MIDAS, we find a significantly positive relation between risk and return in the stock market. This finding is robust in subsamples, to asymmetric specifications of the variance process and to controlling for variables associated with the business cycle. We compare the MIDAS results with tests of the intertemporal capital asset pricing model based on alternative conditional variance specifications and explain the conflicting results in the literature. Finally, we offer new insights about the dynamics of conditional variance.
Nonlinear Pricing Kernels, Kurtosis Preference, and the CrossSection of Assets Returns
 Journal of Finance
, 2002
"... This paper investigates nonlinear pricing kernels in which the risk factor is endogenously determined and preferences restrict the definition of the pricing kernel. These kernels potentially generate the empirical performance of nonlinear and multifactor models, while maintaining empirical power and ..."
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Cited by 132 (2 self)
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This paper investigates nonlinear pricing kernels in which the risk factor is endogenously determined and preferences restrict the definition of the pricing kernel. These kernels potentially generate the empirical performance of nonlinear and multifactor models, while maintaining empirical power and avoiding ad hoc specifications of factors or functional form. Our test results indicate that preferencerestricted nonlinear pricing kernels are both admissible for the cross section of returns and are able to significantly improve upon linear single and multifactor kernels. Further, the nonlinearities in the pricing kernel drive out the importance of the factors in the linear multifactor model. A PRINCIPAL IMPLICATION OF THE Capital Asset Pricing Model ~CAPM! is that the pricing kernel is linear in a single factor, the portfolio of aggregate wealth. Numerous studies over the past two decades have documented violations of this restriction. 1 In response, researchers have examined the performance of alternative models of asset prices. These models have generally fallen into two classes: ~1! multifactor models such as Ross ’ APT or Merton’s ICAPM, in which factors in addition to the market return determine asset prices; or ~2! nonparametric models, such as Bansal et al. ~1993!, Bansal and Viswanathan ~1993!, and Chapman ~1997!, in which the pricing kernel is not
Empirical pricing kernels
, 2001
"... This paper investigates the empirical characteristics of investor risk aversion over equity return states by estimating a timevarying pricing kernel, which we call the empirical pricing kernel (EPK). We estimate the EPK on a monthly basis from 1991 to 1995, using S&P 500 index option data and a ..."
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Cited by 126 (5 self)
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This paper investigates the empirical characteristics of investor risk aversion over equity return states by estimating a timevarying pricing kernel, which we call the empirical pricing kernel (EPK). We estimate the EPK on a monthly basis from 1991 to 1995, using S&P 500 index option data and a stochastic volatility model for the S&P 500 return process. We find that the EPK exhibits countercyclical risk aversion over S&P 500 return states. We also find that hedging performance is significantly improved when we use hedge ratios based the EPK rather than a timeinvariant pricing kernel.
Household Risk Management and Optimal Mortgage Choice," Quarterly Journal of Economics, forthcoming
, 2003
"... A typical household has a home mortgage as its most significant financial contract. The form of this contract is correspondingly important. This paper studies the choice between a fixedrate (FRM) and an adjustablerate (ARM) mortgage. In an environment with uncertain inflation, a nominal FRM has ri ..."
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Cited by 124 (9 self)
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A typical household has a home mortgage as its most significant financial contract. The form of this contract is correspondingly important. This paper studies the choice between a fixedrate (FRM) and an adjustablerate (ARM) mortgage. In an environment with uncertain inflation, a nominal FRM has risky real capital value whereas an ARM has a stable real capital value. However an ARM can increase the shortterm variability of required real interest payments. This is a disadvantage of the ARM for a household that faces borrowing constraints and has only a small buffer stock of financial assets. The paper uses numerical methods to solve a lifecycle model with risky labor income and borrowing constraints, under alternative assumptions about available mortgage contracts. While an ARM is generally an attractive form of mortgage, a household with a large mortgage, risky labor income, high risk aversion, a high cost of default, and a low probability of moving is less likely to prefer an ARM. The paper also considers an inflationindexed FRM, which removes the wealth risk of the nominal FRM without incurring the income risk of the ARM, and is therefore a superior vehicle for household risk management. The welfare gain from mortgage