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36
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 Term Structure of Interest Rates in a DSGE Model with Recursive Preferences
, 2010
"... We solve a dynamic stochastic general equilibrium (DSGE) model in which the representative household has Epstein and Zin recursive preferences. The parameters governing preferences and technology are estimated by means of maximum likelihood using macroeconomic data and asset prices, with a particul ..."
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Cited by 31 (2 self)
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We solve a dynamic stochastic general equilibrium (DSGE) model in which the representative household has Epstein and Zin recursive preferences. The parameters governing preferences and technology are estimated by means of maximum likelihood using macroeconomic data and asset prices, with a particular focus on the term structure of interest rates. We estimate a large risk aversion, an elasticity of intertemporal substitution higher than one, and substantial adjustment costs. Furthermore, we identify the tensions within the model by estimating it on subsets of these data. We conclude by pointing out potential extensions that might improve the model’s fit.
Disaster risk and business cycles
, 2009
"... This paper proposes a tractable business cycle model with large, volatile, and countercyclical risk premia. Risk premia are driven by a small, exogenously timevarying risk of economic disaster, and macroeconomic aggregates respond to this timevarying risk. The model is consistent with the second m ..."
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Cited by 28 (0 self)
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This paper proposes a tractable business cycle model with large, volatile, and countercyclical risk premia. Risk premia are driven by a small, exogenously timevarying risk of economic disaster, and macroeconomic aggregates respond to this timevarying risk. The model is consistent with the second moments of quantities, of asset returns, and matches well the relations between quantities and asset prices. An increase in the probability of disaster leads to a collapse of investment and a recession, with no current or future change in productivity. Demand for precautionary savings increases, leading yields on safe assets to fall, while spreads on risky securities increase. To assess the empirical validity of the model, I infer the probability of disaster from observed asset prices and feed it into the model. The variation over time in this probability appears to account for a signi…cant fraction of business cycle dynamics, especially sharp downturns in investment and output such as the last quarter of 2008. This is consistent with the thenwidespread fear of a repeat of the
Risk Aversion and the Labor Margin in Dynamic Equilibrium Models”Federal Reserve Bank of San Francisco working paper
, 2010
"... The household’s labor margin has a substantial effect on risk aversion, and hence asset prices, in dynamic equilibrium models even when utility is additively separable between consumption and labor. This paper derives simple, closedform expressions for risk aversion that take into account the house ..."
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Cited by 23 (3 self)
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The household’s labor margin has a substantial effect on risk aversion, and hence asset prices, in dynamic equilibrium models even when utility is additively separable between consumption and labor. This paper derives simple, closedform expressions for risk aversion that take into account the household’s labor margin. Ignoring this margin can wildly overstate the household’s true aversion to risk. Risk premia on assets priced with the stochastic discount factor increase essentially linearly with risk aversion, so measuring risk aversion correctly is crucial for asset pricing in the model. Closedform expressions for risk aversion in models with generalized recursive preferences and internal and external habits are also derived.
Macroeconomics and the Term Structure
, 2010
"... This paper provides an overview of the analysis of the term structure of interest rates with a special emphasis on recent developments at the intersection of macroeconomics and finance. The topic is important to investors and also to policymakers, who wish to extract macroeconomic expectations from ..."
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Cited by 22 (1 self)
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This paper provides an overview of the analysis of the term structure of interest rates with a special emphasis on recent developments at the intersection of macroeconomics and finance. The topic is important to investors and also to policymakers, who wish to extract macroeconomic expectations from longerterm interest rates, and take actions to influence those rates. The simplest model of the term structure is the expectations hypothesis, which posits that longterm interest rates are expectations of future average shortterm rates. In this paper, we show that many features of the con…guration of interest rates are puzzling from the perspective of the expectations hypothesis. We review models that explain these anomalies using timevarying risk premia. Although the quest for the fundamental macroeconomic explanations of these risk premia is ongoing, in‡ation uncertainty seems to play a large role. Finally, while modern finance theory prices bonds and other assets in a single unified framework, we also consider an earlier approach based on segmented markets. Market segmentation seems important to understand the term structure of interest rates during the recent financial crisis.
Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset *
, 2008
"... This paper provides crosscountry empirical evidence on bond risk premia. I construct a panel of zerocoupon nominal government bond yields spanning ten industrialized countries and nearly two decades. I hence compute forward rates and then use two different methods to decompose these forward rates ..."
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Cited by 18 (1 self)
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This paper provides crosscountry empirical evidence on bond risk premia. I construct a panel of zerocoupon nominal government bond yields spanning ten industrialized countries and nearly two decades. I hence compute forward rates and then use two different methods to decompose these forward rates into expected future shortterm interest rates and term premiums. The first method uses an affine term structure model with macroeconomic variables as unspanned risk factors; the second method uses surveys. I find that term premium estimates declined across countries over the sample period, especially in countries that appear to have reduced inflation uncertainty by making substantial changes in the monetary policy frameworks of their central banks. During the recent financial crisis, term premiums have remained flat and even declined further in some countries, perhaps reflecting the effects of quantitative easing actions by many central banks.
Merging simulation and projection approaches to solve highdimensional problems with . . .
, 2014
"... We introduce a numerical algorithm for solving dynamic economic models that merges stochastic simulation and projection approaches: we use simulation to approximate the ergodic measure of the solution, we cover the support of the constructed ergodic measure with a
xed grid, and we use projection ..."
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Cited by 12 (6 self)
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We introduce a numerical algorithm for solving dynamic economic models that merges stochastic simulation and projection approaches: we use simulation to approximate the ergodic measure of the solution, we cover the support of the constructed ergodic measure with a
xed grid, and we use projection techniques to accurately solve the model on that grid. The construction of the grid is the key novel piece of our analysis: we replace a large cloud of simulated points with a small set of "representative " points. We present three alternative techniques for constructing representative points: a clustering method, an epsilondistinguishable set method, and a locallyadaptive variant of the epsilondistinguishable set method. As an illustration, we solve one and multiagent neoclassical growth models and a largescale new Keynesian model with a zero lower bound on nominal interest rates. The proposed solution algorithm is tractable in problems with high dimensionality (hundreds of state variables) on a desktop computer.
News Shocks and the Slope of the Term Structure of Interest Rates.” Unpublished manuscript
"... We provide a new structural interpretation of the relationship between the slope of the term structure of interest rates and macroeconomic fundamentals. We first adopt an agnostic identification approach that allows us to identify the shocks that explain most of the movements in the slope. We find t ..."
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Cited by 9 (1 self)
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We provide a new structural interpretation of the relationship between the slope of the term structure of interest rates and macroeconomic fundamentals. We first adopt an agnostic identification approach that allows us to identify the shocks that explain most of the movements in the slope. We find that two shocks are sufficient to explain virtually all movements in the slope. Impulse response functions for the first shock, which explains 7090 percent of the movements in the slope, lead us to interpret this main shock as a news shock about future productivity. We confirm this interpretation by formally identifying such a news shock as in Barsky and Sims (2009) and Sims (2009). We then assess to what extent a New Keynesian DSGE model is capable of generating the observed slope responses to a news shock. We find that augmenting DSGE models with a term structure provides valuable information to discipline the description of monetary policy and the model’s response to news shocks in general.
A model of timevarying risk premia with habits and production
, 2012
"... This paper develops a new utility specification that incorporates Campbell—Cochrane—type habits into the Epstein—Zin class of preferences. In a simple calibration of a real business cycle model with EZhabit preferences, the model generates a strongly countercyclical equity premium, substantial equi ..."
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Cited by 8 (1 self)
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This paper develops a new utility specification that incorporates Campbell—Cochrane—type habits into the Epstein—Zin class of preferences. In a simple calibration of a real business cycle model with EZhabit preferences, the model generates a strongly countercyclical equity premium, substantial equity return predictability, and a stable riskless interest rate, as in the data. Moreover, conditional on the average level of risk aversion, timevariation in risk aversion increases the volatility and mean return of equities. On the real side, the model matches the short and longterm variances of output, consumption, and investment growth. As an additional empirical test, I measure implied risk aversion and find that it has an R2 of over 50 percent for 5year stock returns in postwar data. Variables that predict stock returns in the data also predict returns in the model with a similar degree of explanatory power.
Monetary Policy Drivers of Bond and Equity Risks ”, working paper
, 2014
"... Stanley Zin for helpful comments and suggestions. This material is based upon work supported by Harvard ..."
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Cited by 5 (2 self)
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Stanley Zin for helpful comments and suggestions. This material is based upon work supported by Harvard