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750
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 & ..."
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Cited by 87 (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.
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 83 (4 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.
Presidential Address: Discount Rates
 Journal of Finance
, 2011
"... Discountrate variation is the central organizing question of current assetpricing research. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with variation in pricedividend ratios due to variation in expected cashflows. Now it seems all pricedividend ..."
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Cited by 79 (2 self)
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Discountrate variation is the central organizing question of current assetpricing research. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with variation in pricedividend ratios due to variation in expected cashflows. Now it seems all pricedividend variation corresponds to discountrate variation. We also thought that the crosssection of expected returns came from the CAPM. Now we have a zoo of new factors. I categorize discountrate theories based on central ingredients and data sources. Incorporating discountrate variation affects finance applications, including portfolio theory, accounting, cost of capital, capital structure, compensation, and macroeconomics. ASSET PRICES SHOULD EQUAL expected discounted cashflows. Forty years ago, Eugene Fama (1970) argued that the expected part, “testing market efficiency,” provided the framework for organizing assetpricing research in that era. I argue that the “discounted ” part better organizes our research today. I start with facts: how discount rates vary over time and across assets. I turn
LongRun Stockholder Consumption Risk and Asset Returns
 Journal of Finance
, 2009
"... Exploiting microlevel household consumption data, we show that longrun stockholder consumption risk captures crosssectional variation in average stock returns, including the size and value premia. To generate a longer timeseries we form factormimicking portfolios for stockholder consumption gro ..."
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Cited by 77 (5 self)
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Exploiting microlevel household consumption data, we show that longrun stockholder consumption risk captures crosssectional variation in average stock returns, including the size and value premia. To generate a longer timeseries we form factormimicking portfolios for stockholder consumption growth that perform at least as well as the FamaFrench factors in asset pricing tests. The stockholder share of aggregate consumption also captures timevariation in stock and bond market returns that mirrors the dynamics of the aggregate consumptiontowealth ratio. We interpret our findings under a model of recursive preferences and find that risk aversion as low as 5 is sufficient to match both the crosssectional price of risk and the equity premium for the wealthiest stockholders.
The market price of aggregate risk and the wealth distribution, Working Paper
, 2001
"... I introduce bankruptcy into a complete markets model with a continuum of ex ante identical agents who have power utility. Shares in a Lucas tree serve as collateral. Bankruptcy gives rise to a second risk factor in addition to aggregate consumption growth risk. This liquidity risk is created by bind ..."
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Cited by 71 (6 self)
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I introduce bankruptcy into a complete markets model with a continuum of ex ante identical agents who have power utility. Shares in a Lucas tree serve as collateral. Bankruptcy gives rise to a second risk factor in addition to aggregate consumption growth risk. This liquidity risk is created by binding solvency constraints. The risk is measured by one moment of the wealth distribution, which multiplies the standard BreedenLucas stochastic discount factor. The economy is said to experience a negative liquidity shock when this growth rate is high, a large fraction of agents faces severely binding solvency constraints and the trading volume is low in financial markets. The adjustment to the BreedenLucas stochastic discount factor induces time variation in equity, bond and currency risk premia that is consistent with the data.
Consumption risk and the cross section of expected returns
 Journal of Political Economy
, 2005
"... This paper evaluates the central insight of the consumption capital asset pricing model that an asset's expected return is determined by its equilibrium risk to consumption. Rather than measure risk by the contemporaneous covariance of an asset's return and consumption growth, we measure ..."
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Cited by 71 (1 self)
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This paper evaluates the central insight of the consumption capital asset pricing model that an asset's expected return is determined by its equilibrium risk to consumption. Rather than measure risk by the contemporaneous covariance of an asset's return and consumption growth, we measure risk by the covariance of an asset's return and consumption growth cumulated over many quarters following the return. While contemporaneous consumption risk explains little of the variation in average returns across the 25 FamaFrench portfolios, our measure of ultimate consumption risk at a horizon of three years explains a large fraction of this variation.
Macro factors in bond risk premia
 Review of Financial Studies
, 2009
"... Are there important cyclical fluctuations in bond market premiums and, if so, with what macroeconomic aggregates do these premiums vary? We use the methodology of dynamic factor analysis for large datasets to investigate possible empirical linkages between forecastable variation in excess bond retur ..."
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Cited by 61 (1 self)
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Are there important cyclical fluctuations in bond market premiums and, if so, with what macroeconomic aggregates do these premiums vary? We use the methodology of dynamic factor analysis for large datasets to investigate possible empirical linkages between forecastable variation in excess bond returns and macroeconomic fundamentals. We find that “real ” and “inflation ” factors have important forecasting power for future excess returns on U.S. government bonds, above and beyond the predictive power contained in forward rates and yield spreads. This behavior is ruled out by commonly employed affine term structure models where the forecastability of bond returns and bond yields is completely summarized by the crosssection of yields or forward rates. An important implication of these findings is that the cyclical behavior of estimated risk premia in both returns and longterm yields depends importantly on whether the information in macroeconomic factors is included in forecasts of excess bond returns. Without the macro factors, risk premia appear virtually acyclical, whereas with the estimated factors risk premia have a marked countercyclical component, consistent with theories that imply investors must be compensated for risks associated with macroeconomic activity. ( JEL E0, E4, G10, G12) 1.
Stock market participation, intertemporal substitution and risk aversion
 Forthcoming, American Economic Review Papers and Proceedings
, 2003
"... Many of the empirical rejections of the consumption CAPM can be explained by the fact that the marginal rate of substitution between present and future consumption, which in the standard model functions as the pricing kernel for all assets for which a consumer is not at a corner, seems to vary too l ..."
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Cited by 61 (2 self)
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Many of the empirical rejections of the consumption CAPM can be explained by the fact that the marginal rate of substitution between present and future consumption, which in the standard model functions as the pricing kernel for all assets for which a consumer is not at a corner, seems to vary too little to be consistent with sensible values of the parameters. Moreover, when one considers more than one asset at a time, one typically gets strong rejections of the overidentifying restrictions implied by the model. The failure seems to be both in terms of unconditional and conditional moments. Two recent papers Attanasio et al., 2002 [henceforth ABT]; VissingJørgensen, 2002 [henceforth VJ] have shown that, if one focuses on the consumption of individuals participating in the stock market, one does not reject some implications of the model. In particular, both VJ and ABT � nd that, using the consumption of stockholders, conditional Euler equations lead to sensible preference parameters and, in the case of ABT, fail to reject the overidentifying restrictions even when considering two assets (stocks and bonds) at the same time. While these results constitute a � rst empirical success, they do not necessarily constitute a solution to the equity premium puzzle. As argued