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983
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 86 (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.
An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns
 Journal of Financial Economics
, 2004
"... The returns to hedge funds and other alternative investments are often highly serially correlated, in sharp contrast to the returns of more traditional investment vehicles such as longonly equity portfolios and mutual funds. In this paper, we explore several sources of such serial correlation and s ..."
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Cited by 83 (4 self)
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The returns to hedge funds and other alternative investments are often highly serially correlated, in sharp contrast to the returns of more traditional investment vehicles such as longonly equity portfolios and mutual funds. In this paper, we explore several sources of such serial correlation and show that the most likely explanation is illiquidity exposure, i.e., investments in securities that are not actively traded and for which market prices are not always readily available. For portfolios of illiquid securities, reported returns will tend to be smoother than true economic returns, which will understate volatility and increase riskadjusted performance measures such as the Sharpe ratio. We propose an econometric model of illiquidity exposure and develop estimators for the smoothing profile as well as a smoothingadjusted Sharpe ratio. For a sample of 908 hedge funds drawn from the TASS database, we show that our estimated smoothing coefficients vary considerably across hedgefund style categories and may be a useful proxy for quantifying illiquidity exposure.
Term Structure of Interest Rates with Regime Shifts
 Journal of Finance
, 2002
"... We develop a term structure model where the short interest rate and the market price of risks are subject to discrete regime shifts. Empirical evidence from efficient method of moments estimation provides considerable support for the regime shifts model. Standard models, which include affine specifi ..."
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Cited by 79 (1 self)
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We develop a term structure model where the short interest rate and the market price of risks are subject to discrete regime shifts. Empirical evidence from efficient method of moments estimation provides considerable support for the regime shifts model. Standard models, which include affine specifications with up to three factors, are sharply rejected in the data. Our diagnostics show that only the regime shifts model can account for the welldocumented violations of the expectations hypothesis, the observed conditional volatility, and the conditional correlation across yields. We find that regimes are intimately related to business cycles. MANY PAPERS DOCUMENT THAT THE UNIVARIATE short interest rate process can be reasonably well modeled in the time series as a regime switching process ~see Hamilton ~1988!, Garcia and Perron ~1996!!. In addition to this statistical evidence, there are economic reasons as well to believe that regime shifts are important to understanding the behavior of the entire yield curve. For example, business cycle expansion and contraction “regimes ” potentially
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 79 (15 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.
Dynamic consumption and portfolio choice with stochastic volatility in incomplete markets
, 2003
"... ..."
"Peso Problem" Explanations for Term Structure Anomalies
, 1997
"... We examine the empirical evidence on the expectations hypothesis of the term structure of interest rates in the United States, the United Kingdom, and Germany using the CampbellShiller (1991) regressions and a vectorautoregressive methodology. We argue that anomalies in the U.S. term structure, do ..."
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Cited by 75 (14 self)
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We examine the empirical evidence on the expectations hypothesis of the term structure of interest rates in the United States, the United Kingdom, and Germany using the CampbellShiller (1991) regressions and a vectorautoregressive methodology. We argue that anomalies in the U.S. term structure, documented by Campbell and Shiller (1991), may be due to a generalized peso problem in which a highinterest rate regime occuued less frequently in the sample of U.S. data than was rationally anticipated. We formalize this idea as a regimeswitching model of shortterm interest rates estimated with data from seven countries. Technically, this model extends recent research on regimeswitching models with statedependent transitions to a crosssectional setting. Use of the small sample distributions generated by the regimeswitching model for inference considerably weakens the evidence against the expectations hypothesis, but it remains somewhat implausible that our datagenerating process produced the U.S. data. However, a model that combines moderate timevariation in term premiums with pesoproblem effects is largely consistent with term structure
A Study towards a Unified Approach to the Joint Estimation of Objective and Risk Neutral Measures for the Purpose of Options Valuation
, 1999
"... The purpose of this paper is to bridge two strands of the literature, one pertaining to the objectiveorphysical measure used to model the underlying asset and the other pertaining to the riskneutral measure used to price derivatives. We propose a generic procedure using simultaneously the fundame ..."
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Cited by 75 (4 self)
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The purpose of this paper is to bridge two strands of the literature, one pertaining to the objectiveorphysical measure used to model the underlying asset and the other pertaining to the riskneutral measure used to price derivatives. We propose a generic procedure using simultaneously the fundamental price S t and a set of option contracts ### I it # i=1;m # where m # 1 and # I it is the BlackScholes implied volatility.We use Heston's #1993# model as an example and appraise univariate and multivariate estimation of the model in terms of pricing and hedging performance. Our results, based on the S&P 500 index contract, show that the univariate approach only involving options by and large dominates. Abyproduct of this #nding is that we uncover a remarkably simple volatility extraction #lter based on a polynomial lag structure of implied volatilities. The bivariate approachinvolving both the fundamental and an option appears useful when the information from the cash market ...
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 75 (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.
Portfolio and consumption decisions under meanreverting returns: An exact solution for complete markets
 Journal of Financial and Quantitative Analysis 37, 63–91. The Journal of Finance Wachter, Jessica A
, 2003
"... This paper solves, in closed form, the optimal portfolio choice problem for an investor with utility over consumption under meanreverting returns. Previous solutions either require approximations, numerical methods, or the assumption that the investor does not consume over his lifetime. This paper ..."
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Cited by 73 (6 self)
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This paper solves, in closed form, the optimal portfolio choice problem for an investor with utility over consumption under meanreverting returns. Previous solutions either require approximations, numerical methods, or the assumption that the investor does not consume over his lifetime. This paper breaks the impasse by assuming that markets are complete. The solution leads to a new understanding of hedging demand and of the behavior of the approximate loglinear solution. The portfolio allocation takes the form of a weighted average and is shown to be analogous to duration for coupon bonds. Through this analogy, the notion of investment horizon is extended to that of an investor who consumes at multiple points in time.