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Financial Stress and Economic Dynamics: The Transmission of Crises”, manuscript
 ECB, Federal Reserve Board and IMF
, 2010
"... In 2014 all ECB publications feature a motif taken from the €20 banknote. NOTE: This Working Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily refl ect those of the ECB. ..."
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In 2014 all ECB publications feature a motif taken from the €20 banknote. NOTE: This Working Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily refl ect those of the ECB.
Stochastic Volatility and Asset Pricing Puzzles
, 2013
"... This paper builds a realoptions, term structure model of the firm to shed new light on the value premium, financial distress, momentum, and credit spread puzzles. The model incorporates stochastic volatility in the firm productivity process and a negative market price of volatility risk. Since the ..."
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Cited by 9 (0 self)
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This paper builds a realoptions, term structure model of the firm to shed new light on the value premium, financial distress, momentum, and credit spread puzzles. The model incorporates stochastic volatility in the firm productivity process and a negative market price of volatility risk. Since the equity of growth firms and financially distressed firms have embedded options, such securities hedge against volatility risk in the market and thus command lower volatility risk premia than the equities of value or financially healthy firms. Abnormal riskadjusted momentum profits are concentrated among low creditrating firms for similar reasons. Conversely, since increases in volatility generally reduce the value of debt, corporate debt will tend to command large volatility risk premia, allowing the model to generate higher credit spreads than existing structural models. The paper illustrates that allowing for endogenous default by equityholders is necessary for the model to account for the credit spreads of both investment grade and junk debt. The model is extended to include rare disasters and multiple time scales in volatility dynamics to better account for the expected default frequencies and credit spreads of short maturity debt. Finally, the paper uses a methodology based on asymptotic expansions to solve the model.
Volatility, the macroeconomy and asset prices
, 2012
"... We show that volatility movements have firstorder implications for consumption dynamics and asset prices. Volatility news affects the stochastic discount factor and carries a separate risk premium. In the data, volatility risks are persistent and are strongly correlated with discountrate news. Thi ..."
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Cited by 8 (0 self)
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We show that volatility movements have firstorder implications for consumption dynamics and asset prices. Volatility news affects the stochastic discount factor and carries a separate risk premium. In the data, volatility risks are persistent and are strongly correlated with discountrate news. This evidence has important implications for the return on aggregate wealth and the crosssectional differences in risk premia. Estimation of our volatility risks based model yields an economically plausible positive correlation between the return to human capital and equity, while this correlation is implausibly negative when volatility risk is ignored. Our model setup implies a dynamics capital asset pricing model (DCAPM) which underscores the importance of volatility risk in addition to cashflow and discountrate risks. We show that our DCAPM accounts for the level and dispersion of risk premia across booktomarket and size sorted portfolios, and that equity portfolios carry positive volatilityrisk premia. We thank seminar participants at NBER Spring 2012 AssetPricing Meeting, AFA 2012, SED
Comomentum: Inferring Arbitrage Activity from Return Correlations, London School of Economics working paper
, 2014
"... at the LSE is gratefully acknowledged. ..."
Rare Events, Financial Crises, and the CrossSection of Asset Returns
, 2008
"... This paper shows that rare events are useful in explaining the cross section of asset returns because they are important in shaping agentsexpectations. I reconsider the "bad beta, good beta " ICAPM and I point out that the explanatory power of the model depends on including the stock marke ..."
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Cited by 4 (1 self)
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This paper shows that rare events are useful in explaining the cross section of asset returns because they are important in shaping agentsexpectations. I reconsider the "bad beta, good beta " ICAPM and I point out that the explanatory power of the model depends on including the stock market crash that opened the Great Depression. When using a Markovswitching VAR, a 30s regime is identi
ed. This regime receives a large weight when forming expectations consistent with the ICAPM. I then generalize this result showing that
nancial variables behave in a substantially di¤erent way during a crisis. Accordingly, the ICAPM delivers excellent results when investors distinguish between a high and a lowuncertainty regime. As a technical contribution, I describe how to estimate a Markovswitching VAR in reduced form. I am grateful to Chris Sims for useful suggestions at the early stage of this work. I thank Robert Barro,
Asset pricing with horizon dependent risk aversion,” Working Paper
, 2014
"... This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New Y ..."
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Cited by 2 (1 self)
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This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
Good and Bad Uncertainty: Macroeconomic and Financial Market Implications
, 2013
"... Does macroeconomic uncertainty increase or decrease aggregate growth and asset prices? To address this question, we decompose aggregate uncertainty into ‘good ’ and ‘bad ’ volatility components, associated with positive and negative innovations to macroeconomic growth. We document that in line with ..."
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Does macroeconomic uncertainty increase or decrease aggregate growth and asset prices? To address this question, we decompose aggregate uncertainty into ‘good ’ and ‘bad ’ volatility components, associated with positive and negative innovations to macroeconomic growth. We document that in line with our theoretical framework, these two uncertainties have opposite impact on aggregate growth and asset prices. Good uncertainty predicts an increase in future economic activity, such as consumption, output, and investment, and is positively related to valuation ratios, while bad uncertainty forecasts a decline in economic growth and depresses asset prices. Further, the market price of risk and equity beta of good uncertainty are positive, while negative for bad uncertainty. Hence, both uncertainty risks contribute positively to risk premia, and help explain the crosssection of expected returns beyond cash flow risk.
CashFlow Maturity and Risk Premia in CDS Markets⇤
, 2012
"... I study the returns of portfolios of Credit Default Swaps of different maturities but the same volatility. I find average returns decrease with maturity. This variation in expected returns is captured by betas with respect to a factor: a portfolio that sells shortmaturity CDSs and buys longmaturit ..."
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I study the returns of portfolios of Credit Default Swaps of different maturities but the same volatility. I find average returns decrease with maturity. This variation in expected returns is captured by betas with respect to a factor: a portfolio that sells shortmaturity CDSs and buys longmaturity ones. This portfolio is a markettiming factor. Its CDSmarket betas are high when the price of CDSmarket risk is high, but low otherwise. Accordingly, a conditional CDS CAPM explains the crosssectional variation in returns by maturity. I embed a conditional CAPM within a structural model of credit risk and show the maturityrelated beta dynamics emerge endogenously.
Does variance risk have two prices? Evidence from the equity and option markets. Working Paper
, 2015
"... Abstract We formally compare two versions of the market variance risk premium (VRP) measured in the equity and option markets. Both VRPs follow common patterns and respond similarly to changes in volatility and economic conditions. However, we reject the null hypothesis that they are identical and ..."
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Abstract We formally compare two versions of the market variance risk premium (VRP) measured in the equity and option markets. Both VRPs follow common patterns and respond similarly to changes in volatility and economic conditions. However, we reject the null hypothesis that they are identical and …nd that their di¤erence is strongly related to measures of the …nancial standing of intermediaries. These results shed new light on the information content of the VRP, suggest the presence of market frictions between the two markets, and are consistent with the key role played by intermediaries in setting option prices. JEL classi…cation: G12, G13, C58
The price of variance risk
, 2014
"... The average investor in the variance swap market is indifferent to news about future variance at horizons ranging from 1 month to 14 years. It is only purely transitory and unexpected realized variance that is priced. These results present a challenge to most structural models of the variance risk p ..."
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The average investor in the variance swap market is indifferent to news about future variance at horizons ranging from 1 month to 14 years. It is only purely transitory and unexpected realized variance that is priced. These results present a challenge to most structural models of the variance risk premium, such as the intertemporal CAPM, recent models with Epstein–Zin preferences and longrun risks, and models where institutional investors have valueatrisk constraints. The results also have strong implications for macro models where volatility affects investment decisions, suggesting that investors are not willing to pay to hedge shocks in expected economic uncertainty. 1