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Forthcoming in Journal of Finance
Abstract: A single macroeconomic factor based on growth in the capital share of aggregate income exhibits significant explanatory power for expected returns across a range of equity characteristic portfolios and non-equity asset classes, with risk price estimates that are of the same sign and similar in magnitude. Positive exposure to capital share risk earns a positive risk premium, commensurate with recent asset pricing models in which redistributive shocks shift the share of income between capital owners, who finance consumption primarily out of asset ownership, and workers, who finance consumption primarily out of wages and salaries.
Heterogeneous Intermediaries and Asset Prices (Under Review)
Abstract: Canonical intermediary asset pricing models assume a representative intermediary with an SDF linear in its leverage. Yet the leverage of broker-dealers is procyclical whereas the leverage of banking holding companies is countercyclical. I propose an empirically testable heterogeneous intermediary stochastic discount factor (HI-SDF) that depends non-linearly on aggregate leverage as well as net worth shares of individual intermediaries. I show that the HI-SDF emerges from general equilibrium models with heterogeneous intermediaries whereas its specific functional form hinges on different models’ specifications of financing constraints. To address this issue, the HI-SDF is estimated semiparametrically. I provide empirical evidence that the wealth distribution among intermediaries is an important source of risk for pricing risky securities. The estimated HI-SDF is found to exhibit substantial explanatory power for cross-sectional variation in expected returns across a wide range of test assets. In contrast to representative intermediary empirical models, the HI-SDF exhibits lower pricing errors and explains larger fractions of the cross-section of expected returns.
Competition and Implementation Cycles (Under Review)
Abstract: This paper studies how innovating firms’ timing decisions on implementing new ideas affect macroeconomic fluctuations with the presence of two sources of competition: imperfect substitutability across products and imitations within products. In order to take advantage of a higher aggregate demand, firms may strategically choose to implement innovative ideas simultaneously with other firms. As a result, implementation cycles emerge endogenously in equilibrium. Using U.S. IPO and Venture-backed companies data, I first provide some empirical evidence on the existence of implementation cycles with an average frequency of 3.7 years. Second, a stylized model shows that smaller substitutability across products and longer imitation processes can contribute to a longer and lower frequent implementation cycle; it, however, has a larger impact on driving the fluctuations of macro variables. Third, when firms can only observe noisy private sunspot signals on others’ implementation decisions, the equilibrium can feature no, short, and long cycles depending on the realization of the sunspots.
Uncertainty and Business Cycles: Exogenous Impulse or Endogenous Response?
with Sydney C. Ludvigson and Serena Ng (Under Revision)
Abstract: Uncertainty about the future rises in recessions. But is uncertainty a source of business cycle fluctuations or an endogenous response to them, and does the type of uncertainty matter? We find that sharply higher uncertainty about real economic activity in recessions is most often an endogenous response to other shocks that cause business cycle fluctuations, while uncertainty about financial markets is a likely source of the fluctuations. To establish the dynamic effects of uncertainty shocks, we exploit information from external variables and the timing of extraordinary economic events to identify structural vector autoregressions under credible interpretations of the structural shocks.
Shock Restricted Structural Vector-Autoregressions
with Sydney C. Ludvigson and Serena Ng (Under Revision)
NBER Working Paper No. 23225
Abstract: Identifying assumptions need to be imposed on autoregressive models before they can be used to analyze the dynamic effects of economically interesting shocks. Often, the assumptions are only rich enough to identify a set of solutions. This paper considers two types of restrictions on the structural shocks that can help reduce the number of plausible solutions. The first is imposed on the sign and magnitude of the shocks during unusual episodes in history. The second restricts the correlation between the shocks and components of variables external to the autoregressive model. These non-linear inequality constraints can be used in conjunction with zero and sign restrictions that are already widely used in the literature. The effectiveness of our constraints are illustrated using two applications of the oil market and Monte Carlo experiments calibrated to study the role of uncertainty shocks in economic fluctuations.
Work in Progress
Growth through Learning
with Boyan Jovanovic (Draft coming soon)
This paper analyzes a decision problem under parameter uncertainty; first that of a single agent, and then for a group of agents that face related problems and that can invest in information that they share. The unknown parameter has a permanent and a transitory component. The N-player game generates growth via statistical learning alone. The equilibrium growth rate rises with agents’ risk aversion and its distribution has a thick right tail. Research entails a free riding problem, but the scale effect dominates and growth rises with the number of agents.
Capital share risk exhibits significant explanatory power for several cross-sections of expected returns, while subsuming much or all of the explanatory power of predominant return-based factor models. For most portfolios, positive exposure to capital share risk earns a positive risk premium, commensurate with recent inequality-based asset pricing models. But in a striking and puzzling exception to this finding, the risk price is strongly negative for momentum. We show that this finding is central for understanding one key feature of the data, namely the negative correlation between value and momentum strategies, both of which earn high average returns.
Asset Prices and Dynamic Intermediation Chains in OTC Markets (Under Major Revision)
Abstract: Transactions in over-the-counter (OTC) markets often involve intermediation chains: multiple dealers are involved in one round-trip transaction. Why are intermediation chains formed in the first place? How does the length of the chain impact underlying asset prices? In order to address these issues, I construct a dynamic search model in which an intermediation chain emerges endogenously in equilibrium. Using TRACE OTC data, the model’s implications for the chain length and bid-ask spread are consistent with both time-series and cross-sectional empirical facts in corporate bond markets.