Papers Recent Discussions / Presentations
"Interest Rate Swaps and Corporate Default", joint with Vivian Y. Yue (revised February 2012)
This
paper studies firms' usage of interest rate swaps to manage risk in a model
economy driven by aggregate productivity shocks, inflation shocks, and
counter-cyclical idiosyncratic productivity risk. Consistent with empirical
evidence, firms in the model are fixed-rate payers, and swap positions are
negatively correlated with the yield spread. In the model, swaps affect firms'
investment decisions and debt pricing only very moderately, and the
availability of swaps generates only small economic gains for the typical firm.
"A Production-Based Model for the Term
Structure", (revised
April 2012)
This
paper considers the term structure of interest rates implied by a
production-based asset pricing model where the fundamental drivers are
investment in equipment and structures, and inflation. The model, calibrated to
match the equity premium and the volatility of stock returns as well as the
mean and volatility of short term yields, matches the average yield curve up to
five year maturity almost perfectly. Longer term yields are roughly as volatile
as in the data. The model also generates time-varying bond risk premiums. In
particular, when running Fama-Bliss regressions of
excess returns on forward premiums, the model produces slope coefficients of
roughly half the size of the empirical counterparts. Closed-form expressions
derived for the continuous-time version of the model highlight the importance
of the capital depreciation rates for interest rate dynamics.
"Paying
More Attention to Financial Shocks", joint with V. Quadrini (September
2009); VOX article describing some of our recent research
"Macroeconomic Effects of Financial Shocks", Appendix
joint with V. Quadrini
(December 2010, forthcoming American Economic Review)
We document the cyclical properties of U.S. firms'
financial flows and show that equity payout is procyclical
and debt payout is countercyclical. We then develop a model with debt and
equity financing to explore how the dynamics of real and financial variables
are affected by `financial shocks'. We find that financial shocks contributed
significantly to the observed dynamics of real and financial variables. The
recent events in the financial sector show up as a tightening of firms'
financing conditions which contributed to the 2008-2009 recession. The
downturns in 1990-91 and 2001 were also influenced by changes in credit
conditions.
"Financial Innovations and Macroeconomic Volatility”, joint
with V. Quadrini (April 2009)
The volatility of
"The Equity Premium Implied by Production", SLIDES, (2010, Journal of Financial Economics 98, 279-296)
This paper studies the determinants of the equity premium as implied by producers'
first-order conditions. A simple closed form expression is presented for the
Sharpe ratio as a function of investment volatility and technology parameters.
Calibrated to the
"Stock Market Boom and the Productivity Gains of the
1990s", joint with V. Quadrini,
(2007, Journal of Monetary Economics)
Together with a sense of entering a New Economy, the US experienced in the
second half of the 1990s an economic expansion, a stock market boom, a
financing boom for new firms and productivity gains. In this paper, we propose
an interpretation of these events within a general equilibrium model with
financial frictions and decreasing returns to scale in production. We show that
the mere prospect of high future productivity growth can generate sizable gains
in current productivity, as well as the other above mentioned events.
"Using Asset Prices to Measure the Persistence of
the Marginal Utility of Wealth", joint with
F. Alvarez, (Econometrica, November 2005, 1977-2016 )
We derive a lower bound for the size of the permanent component of investors'
marginal utility of wealth, or more generally, asset pricing kernels. The bound
is based on return properties of long-term zero-coupon bonds, risk-free bonds,
and other risky securities. We find the permanent component of the pricing
kernel to be very large; its volatility is about at least as large as the
volatility of the stochastic discount factor. We also show that, for many cases
where the pricing kernel is a function of consumption, innovations to
consumption need to have permanent effects.
"Using Asset Prices to
Measure the Cost of Business Cycles", joint
with F. Alvarez, (Journal of Political Economy, December 2004, 1223-56)
We measure the cost of consumption fluctuations using an approach that does not
require the specification of preferences and instead uses asset prices. We
measure the marginal cost of consumption fluctuations, the per unit
benefit of a marginal reduction in consumption fluctuations expressed as a
percentage of lifetime consumption. We find that the gains from eliminating all
consumption uncertainty are very large. However, for consumption fluctuations
corresponding to business cycle frequencies, we estimate the marginal cost to
be between 0.08% and 0.49% of lifetime consumption.
"Quantitative Asset
Pricing Implications of Endogenous Solvency Constraints",
joint with F. Alvarez, (Review of Financial Studies, Winter 2001,
1117-1152)
We study the asset pricing implications of an economy where solvency
constraints are determined to efficiently deter agents from defaulting. We
present a simple example for which efficient allocations and all equilibrium
elements are characterized analytically. The main model produces large equity premia and risk premia for long
term bonds with low risk aversion and a plausibly calibrated income process. We
characterize the deviations from independence of aggregate and individual
income uncertainty that produce equity and term premia.
"EFFICIENCY, EQUILIBRIUM, AND
ASSET PRICING WITH RISK OF DEFAULT," joint with F.
Alvarez, ( Econometrica, July 2000 , 775-797)
We introduce a new equilibrium concept and study its efficiency and asset
pricing implications for the environment analyzed by Kehoe and Levine (1993)
and Kocherlakota (1996). Our equilibrium concept has
complete markets and endogenous solvency constraints. These solvency
constraints prevent default at the cost of reducing risk sharing. We show
versions of the welfare theorems. We characterize the preferences and endowments
that lead to equilibria with incomplete risk sharing.
We compare the resulting pricing kernel with the one for economies without
participation constraints: interest rates are lower and risk premia depend on the covariance of the idiosyncratic and
aggregate shocks. Additionally, we show that asset prices depend only on the
valuation of agents with substantial idiosyncratic risk.
"International Portfolio Diversification
and Endogenous Labor Supply Choice", (European Economic
Review, June 1998, 1141-1172)
This paper presents a multi-country general equilibrium model driven by
productivity shocks, where labor supply and consumption are chosen
endogenously. We use this framework to study the effect of labor supply for
optimal international diversification. We find that the model's ability to help
explain home-bias depends crucially on the level of substitutability between
consumption and non-working time. Quantitatively, the non-separability
in the preferences helps in a nonnegligeable way, but
it cannot entirely explain the extreme degree of home-bias in US portfolios.
"Household Production and
the Excess Sensitivity Consumption to Current Income",
joint with M. Baxter (American Economic Review, September 1999)
Empirical research on the permanent income hypothesis (PIH) has found that consumption
growth is excessively sensitive to predictable changes in income. This finding
is interpreted as strong evidence against the PIH. We propose an explanation
for apparent excess sensitivity that is based on a quantitative equilibrium
version of Becker's (1965) model of household production in which permanent
income consumers respond to shifts in sectoral wages
and prices by substituting work effort and consumption across home and market
sectors. Although the PIH is true, this mechanism generates apparent excess
sensitivity because market consumption responds to predictable income growth.
Keywords: permanent income hypothesis; household production.
"Asset Pricing in Production Economies",
(Journal of Monetary Economics, April 1998, 257-275)
This paper studies asset returns in different versions of the one-sector real
business cycle model. We show that a model with habit formation preferences and
capital adjustment costs can explain the historical equity premium and the
average risk-free return while replicating the salient business cycle
properties. The paper also applies a solution technique that combines loglinear methods with lognormal asset pricing formulae.
"Asset Pricing in
Production Economies", from Economic fluctuations and asset returns",
( revised: May, 1994)
"Nontraded
Goods, Nontraded Factors, and International
Non-Diversification, with M. Baxter and R. G. King, Journal of International
Economics, April 1998, 211-229
"Appendix to: The International
Diversification Puzzle is Worse Than You Think"
(American Economic Review, March 1997, 170-180)
Recent Discussions/Presentations
"Disaster risk and
business cycles," by Francois Gourio,
NBER Summer Institute AP 2010
"Differences of
opinion in an international financial market
equilibrium," by Bernard Dumas, Karen Lewis and Emilio Osambela, NBER IFM Fall 2009
"Collective Risk
Management in a Flight to Quality Episode," by Ricardo Cabelloro
and Arvind Krishnamurthy, NY Fed
Conference 2008
"Inequality,
Stock Market Participation, and the Equity Premium" by Jack Favilukis, ASSA, New Orleans 2008
"Information
Immobility and the Home Bias", by Stijn Van Nieuwerburgh and Laura Veldkamp,
NBER Summer Institute IFM, Boston 2006
"Human Capital,
Business Cycles and Asset Pricing," by Min Wei ASSA
Boston 2006
"Aggregate
Asset Pricing," slides from ESSFM Gerzensee
2004 focus sessions
"Default Risk, the
Exchange Rate and Income Fluctuations in Emerging Economies," by Cristina
Arellano, NBER Summer Institute IFM, July 2004
"Putting the Breaks on Sudden Stops: the Financial Frictions-Moral
Hazard Tradeoff of Asset Price Guarantees," by Bora Durdu
and Enrique Mendoza, Federal Reserve Bank of