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44
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 risk through consumption smoothing
 Review of Financial Studies
, 2010
"... We examine how longrun consumption risk arises endogenously in a standard production economy model where the representative agent has EpsteinZin preferences. Even when technology growth is i.i.d., optimal consumption smoothing induces highly persistent timevariation in expected consumption growt ..."
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Cited by 46 (1 self)
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We examine how longrun consumption risk arises endogenously in a standard production economy model where the representative agent has EpsteinZin preferences. Even when technology growth is i.i.d., optimal consumption smoothing induces highly persistent timevariation in expected consumption growth (longrun risk). This increases the price of risk when investors prefer early resolution of uncertainty, and the model can then account for the low volatility of consumption growth and the high price of risk with a low coe ¢ cient of relative risk aversion. The asset price implications of endogenous longrun risk depends crucially on the persistence of technology shocks and investors preference for the timing of resolution of uncertainty.
Risk Premiums and Macroeconomic Dynamics in a Heterogeneous Agent Model
, 2010
"... We analyze financial risk premiums and real economic dynamics in a DSGE model with three types of agents shareholders, bondholders and workers that differ in participation in the capital market and in attitude towards risk and intertemporal substitution. Aggregate productivity and distribution ris ..."
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Cited by 46 (2 self)
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We analyze financial risk premiums and real economic dynamics in a DSGE model with three types of agents shareholders, bondholders and workers that differ in participation in the capital market and in attitude towards risk and intertemporal substitution. Aggregate productivity and distribution risks are transferred across these agents via the bond market and via an efficient labor contract. The result is a combination of volatile returns to capital and a highly cyclical consumption process for the shareholders, which are two important ingredients for generating high and countercyclical risk premiums. These risk premiums are consistent with a strong propagation mechanism through an elastic supply of labor, rigid real wages and a countercyclical labor share. Based on the empirical estimates for the two sources of real macroeconomic risk, the model generates signi…cant and plausible time variation in both bond and equity risk premiums. Interestingly, the single largest jump in both the risk premium and the price of risk is observed during the current recession.
The CrossSection and TimeSeries of Stock and Bond Returns. Unpublished Working Paper.
, 2010
"... Abstract We propose an arbitragefree stochastic discount factor (SDF) model that jointly prices the crosssection of returns on portfolios of stocks sorted on booktomarket dimension, the crosssection of government bonds sorted by maturity, the dynamics of bond yields, and time series variation ..."
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Cited by 22 (3 self)
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Abstract We propose an arbitragefree stochastic discount factor (SDF) model that jointly prices the crosssection of returns on portfolios of stocks sorted on booktomarket dimension, the crosssection of government bonds sorted by maturity, the dynamics of bond yields, and time series variation in expected stock and bond returns. Its pricing factors are motivated by a decomposition of the pricing kernel into a permanent and a transitory component. Shocks to the transitory component govern the level of the term structure of interest rates and price the crosssection of bond returns. Shocks to the permanent component govern the dividend yield and price the average equity returns. Third, shocks to the relative contribution of the transitory component to the conditional variance of the SDF govern the CochranePiazzesi (2005, CP) factor, a strong predictor of future bond returns. These shocks price the crosssection of booktomarket sorted stock portfolios. Because the CP factor is a strong predictor of economic activity oneto twoyears ahead, shocks to the importance of the transitory component signal improving economic conditions. Value stocks are riskier and carry a return premium because they are more exposed to such shocks.
Likelihood estimation of DSGE models with EpsteinZin preferences
, 2008
"... This paper illustrates how to perform likelihoodbased inference in dynamic stochastic general equilibrium (DSGE) models with EpsteinZin preferences. This class of preferences has recently become a popular device to account for asset pricing observations and other phenomena that are challenging to ..."
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Cited by 17 (5 self)
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This paper illustrates how to perform likelihoodbased inference in dynamic stochastic general equilibrium (DSGE) models with EpsteinZin preferences. This class of preferences has recently become a popular device to account for asset pricing observations and other phenomena that are challenging to address within the traditional stateseparable utility framework. However, there has been little econometric work in the area, particularly from a likelihood perspective, because of the difficulty in computing an equilibrium solution to the model and in deriving the likelihood function. To fill this gap, we build a real business cycle model with EpsteinZin preferences and longrun growth, solve it with perturbation techniques, and evaluate its likelihood with the particle filter. We estimate the model using U.S. macro and yield curve data. We discuss the ability of the model to explain the business cycle, asset prices, the comovements between these two, and the implications of our point estimates for the welfare cost of the business cycle.
Nominal Rigidities, Asset Returns, and Monetary Policy”, unpublished paper, Cheung Kong Graduate School of Business and
, 2013
"... Abstract Assetreturn implications of nominal price and wage rigidities are analyzed in general equilibrium. Nominal rigidities, combined with permanent productivity shocks, increase expected excess returns on production claims. This is mainly explained by consumption dynamics driven by rigidityin ..."
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Cited by 9 (2 self)
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Abstract Assetreturn implications of nominal price and wage rigidities are analyzed in general equilibrium. Nominal rigidities, combined with permanent productivity shocks, increase expected excess returns on production claims. This is mainly explained by consumption dynamics driven by rigidityinduced changes in employment and markups. An interestrate monetary policy rule affects asset returns. Stronger (weaker) rule responses to inflation (output) increase expected excess returns. Policy shocks substantially increase assetreturn volatility. Price rigidity heterogeneity produces crosssectoral differences in expected returns. The model matches important macroeconomic moments and the Sharpe ratio of stock returns, but only captures a small fraction of the observed equity premium. JEL Classification: D51, E44, E52, G12.
Stock prices and monetary policy shocks: A general equilibrium approach
 Journal of Economic Dynamics & Control
, 2014
"... ha l0 ..."
Endogenous Dividend Dynamics and the Term Structure of Dividend Strips 1
, 2012
"... helpful comments. All remaining errors are our own. ..."
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Cited by 8 (0 self)
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helpful comments. All remaining errors are our own.
Learning and the Role of Macroeconomic Factors in the Term Structure of Interest Rates
, 2007
"... Models of the term structure based on only observable variables have had limited success in explaining movements in longerterm interest rates. A key assumption in much of this literature is that agents know all the parameters describing the model of the economy and that these parameters are fixed ..."
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Cited by 6 (1 self)
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Models of the term structure based on only observable variables have had limited success in explaining movements in longerterm interest rates. A key assumption in much of this literature is that agents know all the parameters describing the model of the economy and that these parameters are fixed for all time. In this paper, we relax both of these assumptions and assume that agents regularly reestimate the parameters of their models–both those determining the point forecasts and those describing economic volatility–based on incoming data. In this way, we allow for the realtime problem of pricing assets based on the information set available at the time. In addition, we allow for discounting of past data reflecting a concern on the part of agents for structural change in the economy. We find that the learning model with discounting does a much better job at explaining longerterm yields than an equivalent model with constant coefficients estimated over the full sample; in particular, the deviations from the expectations
InvestmentSpecific Technological Change and Asset Prices
, 2006
"... This paper provides evidence that investmentspecific technological change is a source of systematic risk. In contrast to neutral productivity shocks, the economy needs to invest to realize the benefits of innovations in investment technology. A positive shock to investment technology is followed by ..."
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Cited by 5 (3 self)
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This paper provides evidence that investmentspecific technological change is a source of systematic risk. In contrast to neutral productivity shocks, the economy needs to invest to realize the benefits of innovations in investment technology. A positive shock to investment technology is followed by a reallocation of resources from consumption to investment, leading to a negative price of risk. A portfolio of stocks that produce investment goods minus stocks that produce consumption goods (IMC) proxies for the shock and is a priced risk factor. The value of assets in place minus growth opportunities falls after positive shocks to investment technology, which suggests an explanation for the value puzzle. I formalize these insights in a dynamic general equilibrium model with two sectors of production. The model’s implications are supported by the data. The IMC portfolio earns a negative premium, predicts investment and consumption in a manner consistent with the theory, and helps price the value cross section. 1