Asset Pricing Variables Research Articles

An Intertemporal Preference with Risk and Loss Aversion: Equilibrium Analysis

We study a pure exchange economy with two groups of agents who exhibit different consumption patterns: one changes consumption immediately in response to shocks and the other exhibits stickiness in consumption change. This heterogeneity in the timing and the amount of consumption changes affects the equilibrium dynamics of wealth, and generates business cycles without a major shock to the endowment process. The model is fully tractable in that optimal allocations and the stationary densities of major asset pricing variables are obtained in closed form. The model generates counter-cyclical variation in risk aversion without having an external habit component in the utility function, by which we can explain why the Sharpe ratio, the risk premium, and the stock volatility are counter-cyclical and why the consumption-wealth (or price-dividend, inversely) ratio can predict future returns. The asset pricing moments and yield curves generated by the model match well with the data. Finally, the model also predicts that a (sudden) significant change in the government bond price is accompanied by major consumption revisions by households with sticky consumption without any change in the monetary policy.

MONETARY POLICY SURPRISES, INVESTMENT OPPORTUNITIES, AND ASSET PRICES

AbstractRecent evidence shows that monetary policy announcements convey significant information about expected market returns and are therefore good candidates for innovations in intertemporal asset pricing state variables. I propose an asset pricing model with the market return and a mimicking portfolio for unexpected changes in the federal funds rate on days of Federal Open Market Committee announcements. This economically motivated two‐factor model prices portfolios formed on size, value, momentum, investment, and profitability with an R2 of 80% and an average annual pricing error of 0.93%, performing as well as standard four‐, five‐, and six‐factor models designed to price these assets.

Extreme Returns and Herding of Trade Imbalances*

We estimate the stock’s likelihood of extreme returns by measuring the extent to which the stock’s trades are correlated with market-wide and industry-wide trades during normal times, referred to as herding. We find that stocks whose trades herd most with aggregate-level trades experience most negative (positive) returns during market crashes (booms). While herding generates extreme returns in both sides, investors appear to demand compensation for the possibility of extreme low returns. This is the case even when we control for standard asset pricing variables and other tail risk proxies.

Asset Prices and Consumer Prices: Exploring the Linkages

Abstract It is a well-established fact in monetary economics that money and credit developments may affect consumer price inflation directly as well as indirectly via changes in asset prices, while at the same time asset price fluctuations can independently affect monetary and real developments. This has led to proposals to assign a more prominent role to asset prices in central bank’s toolkit of leading indicators for future developments in consumer price inflation. In this study, we examine, in the context of reduced-form inflation equations, the importance of different variables (including standard explanatory variables) as well as some specific asset price variables (i.e., the changes in housing and equity prices, a yield spread and oil prices). Against this background, we make use of a panel approach, covering data for 17 industrialised countries and the euro area. Three main results emerge out of our analysis. First, a standard framework explaining current inflation by (lagged) developments in infla...

Credit, asset prices and business cycles at the global level

This paper assesses the role of financial variables in real economic fluctuations, in view of analysing the link between financial cycles and business cycles at the global level. A Global VAR modelling approach is used to first assess the contribution of credit and asset price variables to real economic activity in a number of countries and regions. The GVAR model is based on 38 countries estimated over 1987–2013. An analysis on a sample excluding the post-financial crisis period is also provided to check whether financial variables have gained importance in explaining business cycle fluctuations over the recent past. In a second step, financial shocks are identified through sign restrictions in order to illustrate how financial and business cycles could be related. Overall, the paper shows that the importance of credit and asset price variables in explaining real economic fluctuations is relatively large, but has not significantly increased since the global financial crisis. The international transmission of financial shocks on business cycle fluctuations also tends to be large and persistent.

An explicitly solvable Heston model with stochastic interest rate

This paper deals with a variation of the Heston hybrid model with stochastic interest rate illustrated in Grzelak and Oosterlee (2011). This variation leads to a multi-factor Heston model where one factor is the stochastic interest rate. Specifically, the dynamics of the asset price is described through two stochastic factors: one related to the stochastic volatility and the other to the stochastic interest rate. The proposed model has the advantage of being analytically tractable while preserving the good features of the Heston hybrid model in Grzelak and Oosterlee (2011) and of the multi-factor Heston model in Christoffersen et al. (2009). The analytical treatment is based on an appropriate parametrization of the probability density function which allows us to compute explicitly relevant integrals which define option pricing and moment formulas. The moments and mixed moments of the asset price and log-price variables are given by elementary formulas which do not involve integrals. A procedure to estimate the model parameters is proposed and validated using three different data-sets: the prices of call and put options on the U.S. S&P 500 index, the values of the Credit Agricole index linked policy, Azione Più Capitale Garantito Em.64., and the U.S. three-month, two and ten year government bond yields. The empirical analysis shows that the stochastic interest rate plays a crucial role as a volatility factor and provides a multi-factor model that outperforms the Heston model in pricing options. This model can also provide insights into the relationship between short and long term bond yields.

Returns and Information Transmission Dynamics in Public and Private Real Estate Markets

This paper examines U.S. public and private commercial real estate returns at the aggregate level and by the four major property types over the 1994–2012 time period. Returns are carefully adjusted for differences between public and private markets in financial leverage, property type focus and management fees. Unconditionally, we find that passive portfolios of unlevered core real estate investment trusts (REITs) outperformed their private market benchmark by 49 basis points (annualized) over the 1994–2012 sample period. Our baseline vector autoregression results suggest that REIT returns do not embed additional commercial real‐estate‐specific information useful in predicting private market returns. These results strongly suggest that equity REIT returns react to fundamental (latent) asset pricing information more quickly than private market returns given their greater liquidity and price revelation. REITs therefore serve as a fundamental information transmission channel to private market returns when asset pricing variables are omitted.

How beneficial was the Great Moderation after all?

This paper computes the welfare effect of the Great Moderation, using a representative-agent consumption-based asset pricing model. The Great Moderation is modeled according to the data properties of consumption and dividend growth rates, which display a reduction of their innovation-volatility and increased persistence: the latter is a characteristic that has been largely unaddressed in the literature. The theoretical model (a long-run risk model) is calibrated to match average asset pricing variables, as well as consumption and dividend dynamics before and during the Great Moderation. The model captures the relevant features of the Great Moderation (decreased variance, increased persistence, asset prices). It predicts only a modest welfare gain from Great Moderation (0.38 percent in consumption equivalent), due mainly to the utility cost of a late uncertainty resolution.

Do Asset Prices Help to Predict Consumer Price Inflation?

With goods prices being sticky, monetary impulses are initially transmitted to the real economy via changes in asset prices; and asset price fluctuations can independently affect monetary and real developments. Most empirical models try to incorporate such monetary–asset price interactions by the inclusion of a short‐term interest rate and the exchange rate, but there are good reasons to doubt the sufficiency of this. Here we examine whether the predictive power of a reduced form equation for inflation, including standard explanatory variables, can be improved by adding other asset price variables, i.e. the changes in housing and equity prices and a yield spread. In our cross‐country time series exercise, we find that housing price movements do provide useful extra information on future inflation, with equity prices and the yield spread being somewhat less informative.