Research
ARTICLES
OK, the whole point of my research agenda is that asset pricing and macroeconomics are the same thing, but it's still a little helpful to separate papers by their main focus.
By topic, in reverse chronological order
Asset Pricing and Financial Economics
The Dog and the Straw Man: Response to “Dividend Growth Does Not Help Predict Returns Compared To Likelihood-Based Tests: An Anatomy of the Dog”. Click title for longer summary
Published (advance access) Review of Asset Pricing Studies July 2020. I investigate a representation of technology in which producers can transform output across states of nature. This representation lets us write down a complete production-based asset pricing model, in which the discount factor equals marginal rates of transformation.
2017. University of Chicago Press. Edited with Toby Moskowitz. Collection of Gene Fama papers, with introductions by myself, Toby, Ken French, Bill Schwert, René Stulz, Cliff Asness, John Liew, Ray Ball, Dennis Carlton, Cam Harvey, Lan Liu, Amit Seru and Amir Sufi. The introductions explain why the papers are so important and how we think about the issues today. My essays are here, other essays may be on other authors' webpages. For everything else you'll have to buy the book or e book. My essays (most joint with Toby):
Preface;
Efficient Markets and Empirical Finance;
Luck vs. Skill;
Risk and Return;
Return Forecasts and Time Varying Risk Premiums;
Our Colleague.
2017. Review of Finance 21(3): 945-985. Links: Publisher (doi) , Last manuscript. This is a review paper. I survey many current frameworks including habits, long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes, and debt or institutional finance. I stress how all these approaches produce quite similar results and mechanisms: the market's ability to bear risk varies over time, with business cycles. I speculate with some simple models that time-varying risk premiums can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, rather than Keynesian flow constraints or new-Keynesian intertemporal substitution. The July 2016 manuscript contains a long section with thoughts on how to make a macro model based on time varying risk premiums, that got cut from the above final version. (This is the "manuscript" referenced in the paper.) The Data and programs (zip, matlab). The slides for the talk. A very nice post on the Review of Finance Blog summarizing the paper, by Alex Edmans, the editor. Typo: equation (17) is wrong. The same equation, (3) is right.
November 2015 In David Wessel, Ed., The $13 Trillion Question: Managing the U.S. Government's Debt, pp. 91-146. Washington DC: Brookings Institution Press. Last manuscript. I propose a restructuring of U. S. Federal debt. All debt should be perpetual, paying coupons forever with no principal payment. The debt should be composed of 1) Fixed-value, floating-rate, electronically transferable debt. Such debt looks like a money-market fund, or reserves at the Fed, to an investor. 2) Nominal perpetuities: This debt pays a coupon of $1 per bond, forever. 3) Indexed perpetuities: This debt pays a coupon of $1 times the current consumer price index (CPI). 4) All debt should be free of income, estate, capital gains, and other taxes. 5) long term debt should have explicitly variable coupons. 6) Swaps. The Treasury should adjust maturity structure, interest rate and inflation exposure of the Federal budget by transacting in simple swaps among these securities.
November 2015. Journal of Political Economy 123(5) 1214-1226. With John Y. Campbell. (JSTOR / JPE Link.) A rejoinder to Ljungqvist and Uhlig "Comment on the Campbell-Cochrane Habit Model" (formerly titled "Optimal Endowment Destruction under Campbell-Cochrane Habit Formation"). The benefits of endowment destruction depend sensitively on how you discretize the model. Lesson: It's better to use the the continuous time version and make sure discretizations make sense. There is a nice lesson on how to extend diffusion models to jumps too. Computer program.
November 4 2014. In Martin Neil Baily, John B. Taylor, eds., Across the Great Divide: New Perspectives on the Financial Crisis, Hoover Press. This is an essay about what I think we should do in place of current financial regulation. We had a run, so get rid of run-prone liabilities. Technology and financial innovation means we can overcome the standard objections to "narrow banking." Some fun ideas include a tax on debt rather than capital ratios, the Fed and Treasury should issue reserves to everyone and take over short-term debt markets just as they took over the banknote market in the 19th century, and downstream fallible vechicles can tranche up bank equity.
Journal of Legal Studies 43 S63-S105 (November 2014). Is cost benefit analysis a good idea for financial regulation? I survey the nature of costs and benefits of financial regulation and conclude that the legal process of current health, safety and environmental regulation can't be simply extended to financial regulation. I opine about how a successful cost-benefit process might work. My costs and benefits expanded to a rather critical survey of current financial regulation. It's based on a presentation I gave at a conference on this topic at the University of Chicago law school Fall 2013, with many interesting papers. JSTOR link with HTML and nicer pdf. The JLS issue with all conference papers.
Journal of Finance, 69: 1–49. doi: 10.1111/jofi.12099 (February 2014) (link to JF) (Manuscript) Applies good old fashioned mean-variance portfolio analysis to the entire stream of dividends rather than to one-period returns. Long-Run Mean-Variance Analysis in a Diffusion Environment is a set of notes, detailing all the trouble you get in to if you try to apply long-run ideas to the standard iid lognormal environment, and also discusses shifting bliss points a bit.
May 2013 Journal of Economic Perspectives 27, 29–50 JEP link (Previous title "Is Finance Too big?" December 2012.) Is finance "too big?" Is this the right question? .
Joural of Finance 66, 1047-1108 (August 2011). My American Finance Association Presidential speech. The video (including gracious roast by Raghu Rajan) The slides. Data and programs (zip file) Price should equal expected discounted payoffs. Efficiency is about the expected part. The unifying theme of today's finance research is the discounted part -- characterizing and understanding discount-rate variation. The paper surveys facts, theories, and applications, mostly pointing to challenges for future research.
Jan 2010 Regulation 32(4), 34-37. The financial crisis is mainly about too big to fail expectations. The only way out is to limit the government’s authority to bail out.
Manuscript July 24 2008. In a “state-space” model, you write a process for expected returns and another one for expected dividend growth, and then you find prices (dividend yields) and returns by present value relations. I connect state-space models with VAR models for expected returns. What are the VAR or return-forecast-regression implications of a state-space model? What state-space model does a VAR imply? I start optimistic. An AR(1) state-space model gives a nice return-forecasting formula, in which you use both the dividend yield and a moving average of past returns to forecast future returns. The general formulas leave me pessimistic however. One can write any VAR in state-space form, and we don’t really have solid economic reasons to restrict either VAR or state-space representations. Still, the connections between the two representations are worth exploring, and if you’re doing that this paper might save you weeks of algebra.
(with Francis Longstaff and Pedro Santa-Clara), Review of Financial Studies 21 (1) 2008 347-385. We solve the model with two Lucas trees, iid dividends and log utility. Surprise: it has interesting dynamics. If one stock goes up it is a larger share of the market. Its expected return must rise so that people are willing to hold it despite its now larger share. Typo: Equation 39 (page 363), the numerator should read (1-s/(1-s))ln(s)/V, not 1-s/(1-s)ln(s)/V. Thanks to Egor Malkov.
Manuscript, first big revision, March 14 2008. With Monika Piazzesi. We work out an affine term structure model that incorporates our bond risk premia from “Bond Risk Premia” in the AER. There are lots of interesting dynamics – level, slope and curvature forecast future bond risk premia, and we discover that market prices of risk are really simple. We use the model to decompose the yield curve – given a yield (forward) curve today, how much is expected future interest rates, and how much is risk premium? How does the yield or forward rate premium correspond to the term structure of expected return premia? Was the conundrum a conundrum? Slides from 2010 AFA meetings Data and Programs.
In Rajnish Mehra, Ed. Handbook of the Equity Premium Elsevier 2007, 237-325. Everything you wanted to know, but didn’t have time to read, about equity premium, consumption-based models, investment-based models, general equilibrium in asset pricing, labor income and idiosyncratic risk.
Feb. 20 2007 This is a draft of a portfolio theory chapter for the next revision of Asset Pricing. I (of course) take a p = E(mx) approach to portfolio theory before covering the classic Merton-style direct approach. I emphasize the importance of outside income.
Review of Financial Studies 21(4) 2008 1533-1575. Taken alone, returns may not look that predictable. However, price-dividend ratios vary, so either returns or dividend growth must be forecastable (or both). Implications for dividends, and long-run forecasts give strong statistical evidence against the null that returns are not forecatsable. I address the Goyal-Welch finding that forecasts do badly out of sample, and the long literature criticizing long-run forecasts. The most important practical takeaway: even if you assume that all variation in market p/d ratios comes from time-varying expected returns, and none corresponds to dividend growth forecasts, you will typically find that market-timing strategies based on fitting the regression don’t work. Corrected Table 6. Three numbers were wrong in the published version. Thanks to Camilla Pederson for catching it.
With Michael Brandt and Pedro Santa Clara. Published Journal of Monetary Economics 53 (4) May 2006 671-698. Original July 2001 (NBER WP 8404) The equity premium means that marginal rates of substitution are very volatile, with more than 50% standard deviation. Exchange rates are the ratio of marginal rates of substitution, and they only vary by about 12%. Therefore, marginal rates of substitution must be highly correlated across countries. Risk sharing is better than you think.
With Monika Piazzesi. American Economic Review 95:1, 138-160 (2005). We forecast one year bond excess returns with a 44% R2! More importantly, a single factor, a single linear combination of yields or forward rates, forecasts one-year returns of all maturity bonds. Read here the Appendix with lots of extra analysis. (Updated Sept 2006 to fix typos in forward rate formulas.) The NBER working paper has lots of cool stuff, including links to macro and the covariance with level result, that got trimmed from the published paper. Data and programs. Look at the pretty plot of how our forecasts work out of sample since we wrote the paper (Until the 2008 financial crisis, in which the Fama-Bliss procedure breaks down.) Read the Response to Ken Singleton regarding his criticism of our results in a paper with Dai and Yang, and then published in his book Empirical Dynamic Asset Pricing (Princeton, 2006). Overheads, useful if you want to teach the paper A summary with color graphs, and treatment of the period since the 2008 financial crisis, in lecture note form. Start on p 567.
NBER reporter, Jan 2005. A review of these issues in asset pricing.
(published version) Journal of Financial Economics, Volume 75, Issue 1, January 2005, 3-52. Last Manuscript Estimates the mean return, standard deviation, alpha and beta of venture capital investments, correcting for selection bias that we only see returns for successful projects. Even if you don’t like venture capital, the selection bias correction is interesting. Original December 2000. Appendix containing data and program descriptions plus extra algebra. See above data and programs link for data and programs.
May 2002. Published in William C. Hunter, George G. Kaufman and Michael Pomerleano, Eds., Asset Price Bubbles Cambridge: MIT Press 2003. The “arbitrage opportunity” in Palm vs. 3Com stock might be like the arbitrage opportunity between money and treasury bills. I document many similar features, including high turnover in the “overpriced” security. Presented at the Chicago Fed Conference on asset price bubbles, April 2002.
Journal of Political Economy 109, (October 2001),1150-1154. Review of the very nice book by Peter Garber, looking at the facts behind the tulip “bubble” and related myths. It turns out they are mythical. I had a lot of fun with this one.
(With John Y. Campbell). Journal of Finance 55(6) (December 2000) 2863-2878. The CAPM outperforms the consumption-based model in artificial data from the habit persistence model used in "By force of Habit.."
Manuscript, July 2000 A short note showing how Kan and Zhou (1999) went wrong. Adapted from comments I gave to Jagannathan and Wang given at the spring 2000 NBER asset pricing meeting. The Journal of Finance does not publish corrections, even to flat-out mistakes, alas.
(With Jesus Saa-Requejo.) Journal of Political Economy 108, 79-119, 2000 We add a Sharpe ratio or discount factor volatility constraint to the standard no-arbitrage restriction and obtain useful bounds on option prices in environments that don't allow perfect replication. Most importantly we show how to do this in multiperiod and continuous-time, continuous-trading environments, and there are lots of applications and pretty pictures. Final manuscript with algebra appendix
Economic Perspectives XXIII (3) Third quarter 1999 (Federal Reserve Bank of Chicago), also NBER working paper 7170. This is a review and interpretation of how portfolio theory should adapt in a multifactor, predictable world described in New Facts in Finance. See especially the three dimensional update of the two fund theorem.
Economic Perspectives XXIII (3) Third quarter 1999 (Federal Reserve Bank of Chicago), also NBER working paper 7169. This is a review essay of the transition from unpredictable returns and CAPM to predictable returns and multifactor models.
A trio of review papers: These are fun, but I updated the themes and expanded them in subsequent reviews, including Asset pricing, Discount Rates and Financial markets and the real economy.
Macroeconomics, Monetary Economics, and Fiscal Theory of the Price Level
"A prince, who should enact that a certain proportion of his taxes be paid in a paper money of a certain kind, might thereby give a certain value to this paper money." (Adam Smith, Wealth of Nations, Vol. I, Book II, Chapter II. Thanks to Ross Starr for the quote).
A draft book on monetary-fiscal foundations of the euro. With Luis Garicano and Klaus Masuch. Click the title for more information. Read the book>
April 25 2024. What is the basic theory of inflation under interest rate targets? Do higher interest rates lower inflation, and if so, how? The Paper> Slides>
Fiscal Narratives for US Inflation. Jan 28 2024. Comments on Chris Sims “Origins of US Inflation Since 1950” at the 2024 AEA meetings. It is mostly a distillation previous writing and talks, trying to tell the story of US inflation episodes from a fiscal theory point of view. Slides here.
Comments on “Downward Nominal Rigidities and Bond Premia” by François Gourio and Phuong Ngo, at the Fall 2023 NBER Asset Pricing meeting. (November 2023). My slides are here. A YouTube video of the conference is here, I start at 7:35. A bit of term premium, and a longer complaint about the continued use of NK models with known pathologies.
A book on fiscal theory, Princeton University Press. Click the above title for more information and resources.
Nov 7 2022. Journal of Economic Perspectives 36 (4) p. 125–146. I use fiscal theory to interpret historical episodes. Last Manuscript. Click the title for more information.
May 23 2022. An essay, underlying my presentation at the Hoover Monetary Policy Conference May 6 20-22. There is a model by which the Fed is not behind the curve. Is it right? Stopping inflation will require coordinated fiscal and monetary policy.
April 22 2022. The covid inflation was a classic fiscal helicopter drop. It was not a monetary drop. Click on the title for more details.
12/10/2021. I try to boil down the economic analysis in the 600 page book to a readable article with no equations.
A talk given at the UCSD Economics roundtable June 11 2021. Inflation, Fed policy, fiscal pressures, and a quick tour of the Fed’s entrenchment of bailouts, and forays to climate change and social justice. Youtube video here, slides here, blog post with a bit more commentary here.
Published June 2022. Review of Economic Dynamics 45:22-40. Unexpected inflation comes basically all from discount rates: a higher real interest rate devalues government debt via inflation. Big deficits and lower inflation are not a puzzle: discount rates decline. Click the title for more details.
Published June 2022. Review of Economic Dynamics 45:22-40. Fiscal theory of monetary policy means interest rate targets, sticky prices, and fiscal theory. This paper adds long term debt and the crucial novelty: a surplus process by which the government borrows now and promises future surpluses to repay the debt, yet fiscal policy is active. The model generates reasonable response functions to fiscal and monetary policy shocks, and solves a long-standing problem in fiscal theory models. Click title for more information.
February 2021. r<g is an essay on why we still have to repay debts despite r<g. Based on comments on Ricdardo Reis’ r<g paper spring 2021 NBER EFG. Click the title for longer description. Read the essay>
This is a talk I gave at the European Central Bank (zoom) Oct 20 2020. I survey the broad challenges facing the ECB and other central banks in a policy review, from interest rates and inflation, to financial regulation, to a list of risks to worry about, and closing thoughts on the wisdom of central banks embarking on climate change policy. pdf here. conference website with other papers and video.
This was the 2020 Homer Jones Memorial Lecture at the Federal Reserve Bank of St. Louis. Video of the lecture and more here. The article, (html) (pdf) (local pdf) in the Federal Reserve Bank of St. Louis Review, Second Quarter 2020, 102(2), pp. 99-119. Many thanks to the St. Louis Fed, and gracious host Jim Bullard.
Here I apply an asset pricing style price/dividend variance decomposition to the government debt valuation equation, to break the debt / GDP ratio into expected future surpluses and expected growth-adjusted discount rates. Variation in the value of debt / GDP is about half future surpluses and half discount rates. Growth variation does not show up.
2018. NBER Macroeconomics Annual 32 (1) 113-226, Jonathan A. Parker and Michael Woodford Eds. The fact that inflation is quiet and stable at zero rates cleanly invalidates the standard old-Keynesian model, which predicts a deflation spiral, and almost as cleanly invalidates new-Keynesian sunspots. New Keynesian price stickiness plus fiscal theory selection works well, and solves the puzzles of new-Keynesian models with selection by post-bound active policy. Stable inflation suggests a higher rate will raise inflation. That conclusion is hard to escape, even temporarily. The fiscal theory with long term debt does it. Even that does not rescue traditional views of monetary policy. A shortish nontechnical summary. Data and Programs. Last manuscript with online appendix. Published version (pdf) at the University of Chicago Press website. Full text html of the published version.
European Economic Review 101, 354-375. The fiscal theory of the price level can describe monetary policy: interest rate targets, quantitative easing, and forward guidance. With long term debt, a higher interest rate can produce temporarily lower inflation. The paper starts with a completely frictionless environment, and then replicates Chris Sims's "stepping on a rake" paper, which has the latter result along with elaborations that smooth out the impulse-response functions. I boil Sims down to the central ingredient,long term debt. The replication is useful if you want to know how Sims derived his model or solved it; also useful as a guide to solving continuous-time sticky-price models with jumps. matlab program archive
Journal of Monetary Economics. 92, 47-63. Online appendix at the first link or here. matlab program. In standard solutions, new-Keynesian models produce a deep recession with deflation at the zero bound. Useless government spending, technical regress, and capital destruction have large positive multipliers. The recession, deflation and policy paradoxes are larger when prices are less sticky, and news has larger effects for events further in the future. These features are all artifacts of equilibrium selection. For the same interest-rate policy, equilibria that limit a downward jump of inflation on news of the trap, for the same interest rate policy, reverse all these predictions. They predict mild inflation, little output variation, and negative multipliers during the liquidity trap. Their predictions approach the frictionless model smoothly, and promises in the far-off future have less effect today. A big deflation requires that the government raise taxes or cut spending a lot to pay a windfall to bondholders. Such fiscal considerations suggest the equilibria with limited jumps and effects.
January 2015. Chris Sims' (2013) "Paper Money" seems to include a criticism of my "Determinacy and Identification with Taylor Rules." In fact, there is no fundamental disagreement between the two papers.
Journal of Economic Dynamics & Control 49 (2014), 74-108. ( ScienceDirect link to published version, html and pdf) I analyze monetary policy with interest on reserves and a large balance sheet. I argue for the desirability of this regime on financial stability grounds. I show that conventional theories do not determine inflation in this regime, so I base the analysis on the fiscal theory of the price level. I find that monetary policy -- buying and selling government debt with no effect on surpluses -- can peg the nominal rate, and determine expected inflation. With sticky prices, monetary policy can also affect real interest rates and output, though not with the usual signs in this model. Figures 2 and 3 are the best part -- the effects of monetary policy with and without fiscal coordination. I address theoretical controversies, and how the fiscal backing of monetary policy was important for the 1980s disinflation. A concluding section reviews the role of central banks. Matlab program.
Foundations and Trends in Finance 6 (2011), 165-219. How to do ARMA models, opreator tricks, and Hansen-Sargent prediction formulas in continuous time.
National Affairs 9 (Fall 2011). html An essay summarizing the threat of inflation from large debt and deficits. The danger is best described as a "run on the dollar." Future deficits can lead to inflation today, which the Fed cannot control. I also talk about the conventional Keynesian (Fed) and monetarist views of inflation, and why they are not equipped to deal with the threat of deficits. This essay complements the academic (equations) "Understanding Policy" article (see below) and the Why the 2025 budget matters today WSJ oped (on oped page).
Journal of Political Economy, Vol. 119, No. 3 (June 2011), pp. 565-615. Online Appendix B. JSTOR link, including html, pdf, and online appendix. Manuscript with Technical Appendix The technical appendix documents a few calculations. Don't miss starting on Technical Appendix page 6 a full analytical solution to the standard three equation model. I include the manuscript just so equation references in the Technical Appendix will work, the previous links to the published version are better.
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European Economic Review 55 2-30 ScienceDirect Link.
Why there was a big recession; will we face inflation or deflation, can the Fed do anything about it? Many facets of the current situation and policy make sense if you ask about joint fiscal and monetary policy. A fiscal inflation will look much different than most people think. Slides that go with the paper. Appendix with the algebra for government debt valuation equations. A short simple version, my presentation at the Fall NBER EFG conference. A video of a short presentation given to the University Alumni Club in New York, October 2010. Slides for the New York talk if you were there
Journal of Monetary Economics 56 (2009) 1109–1113. JME link .This is a response to Bennett McCallum’s “is the New-Keynesian Analysis Critically Flawed” which says yes. I think McCallum got it backwards -- the bounded equilibrium is not learnable, the explosive ones are learnable. Furthermore, I’m not convinced that a hypothetical threat by the Fed to take us to an “unlearnable” equilibrium is a satisfactory foundation for price level determination.
Journal of Monetary Economics 52:3, (2005) 501-528. Revision of NBER Working Paper 7498 Feb. 2000. The fiscal theory of the price level made simple. The `government budget constraint' is not a constraint. I reopen the security market at the end of the day in a cash in advance model, and show that the price level is still determinate. I also resolve the criticism that the fiscal theory mistreats the "government budget constraint."
(paper, and powerpoint presentation) January 2003. The choice of monetary regime – interest rate rule, exchange rate peg, currency board, dollarization, etc. depends on fiscal constraints, especially for developing countries. Talk given at the 2003 NBER/NCAER Neemrana conference, India.
American Economic Review 92 (2002), 90-95. With Monika Piazzesi (previously NBER WP 8839) . We measure monetary policy shocks by how they surprise daily bond markets. There's a beautiful Taylor rule in interest rate forecasts.
In Economic Transition in Eastern Europe and Russia: Realities of Reform, Edward Lazear Ed., Hoover Institution Press, 1995. Imagine for a moment that the Federal Reserve imposed the following policies in the United States: Every company must pay for all its inputs before they are shipped, and taxes must also be prepaid. But there is no trade credit, and banks do not make working capital loans to purchase inputs. Checks take 90 days to clear… Chaos would result… This is roughly what happened in Russia during the summer of 1992. The story… points to the importance of macroeconomic policies, and the unintended macroeconomic effects of policy, in understanding developments in Russia and the Former Soviet Union. It also suggests that many macroeconomic problems are not inevitable consequences of the transition to a market economy, but rather that they are avoidable unintended effects of partial liberalizations.
Health Insurance, Health Economics
In The Future of Healthcare Reform in the United States Edited by Anup Malani and Michael H. Schill, p 161-201, University of Chicago Press. An essay on health care, first presented at the conference, The Future of Health Care Reform in the United States, at the University of Chicago Law School. Most of the policy discussion is focused on health insurance. But the health care market is dysfuctional, and needs to be fixed as well. Where are the Southwest Airlines, Walmart and Apple of health care, bringing cost saving, efficiency, and innovation? I argue that we need a big freeing up of health care markets. I also focus more than usual on supply restrictions. It doesn't do much good for people to pay with their own money if suppliers cannot respond to that demand. Last manuscript in case of copyright problems with the published version above.
Feb. 18 2009. In Cato's Policy Analysis No 633. If you get sick and lose health insurance you are stuck -- your premiums skyrocket or you may not be able to get insurance at all. The article shows how private markets can solve this problem. If you get sick, your health premiums go up but a separate "premium increase insurance contract" pays a lump sum so that you can afford the higher health premiums. The big advantage is freedom and competition: now health insurance can freely compete for all customers all the time. This piece is written for a nontechnical popular audience, with a lot of policy discussion. This paper explains the basic framework of Time-Consistent Health Insurance (next) and thinks through lots of real-world issues and answers to "what ifs." "What to do about pre-existing conditions" in the Wall Street Journal August 14 2009 and Health Status insurance Investors Business Daily (local link) April 2 2009 are op-eds explaining the basic idea.
Journal of Political Economy, 103 (June 1995) 445-473. None of us has health insurance, really. You get sick, you lose your job or get divorced, and now you have a preexisting condition. This paper shows how to implement “premium increase insurance” that gets around the problem. If you get sick, you get a lump sum that allows you to pay higher insurance premiums. It allows a private-market solution to the main problem of health insurance attracting regulation.
Time-series; Unit Roots; Permanent and Transitory Components
In Rajnish Mehra, Ed. Handbook of the Equity Premium Elsevier 2007, 237-325. Everything you wanted to know, about the equity premium, consumption-based models, investment-based models, general equilibrium in asset pricing, labor income and idiosyncratic risk. Click the title for more information.
This is a short note, showing how money demand estimation works very well in levels or long (4 year) differences, but not when you first-difference the data. It shows why we often want to run OLS with corrected standard errors rather than GLS or ML, and it cautions against the massive differencing, fixed effects and controls used in micro data. It's from a PhD class, but I thought the reminder worth a little standalone note.
Foundations and Trends in Finance 6 (2011), 165-219. How to do ARMA models, opreator tricks, and Hansen-Sargent prediction formulas in continuous time.
Jan 2005 Lecture notes for PhD time series course. This revision finally includes the figures!
Quarterly Journal of Economics CIX (February 1994) 241-266. This is my favorite solution to the permanent/transitory decomposition issue for GNP and stock prices. I use bivariate autoregressions of consumption and GNP, and of dividends and stock prices. Consumption and dividend growth are unpredictable, so act as stochastic trends for GNP and stock prices. A movement in stock prices with no current change in dividends is completely transitory, so can be labeled an “expected return” shock. A movement in stock prices with a change in dividends is permanent and so is a “permanent earnings” shock. Note the QJE switched Figure II and III.
Journal of Economic Dynamics and Control 15 (April 1991) 275-284. Running a battery of unit root/cointegration tests and then imposing the answers on subsequent analysis is a bad idea. Alas, there is no substitute for plotting the data and thinking about what makes sense.
Journal of Political Economy 96 (October 1988) 893-920. Short-order ARMA models suggest that GNP looks a lot like a random walk. But short-order ARMA models are fit to match one-step ahead forecasts, and can do a poor job of capturing long-term forecastability. I used a variance-ratio statistic (variance of long-term differences / variance of one-year differences) to show that there is a lot of mean-reversion in GNP that short-order ARMA models miss. I think the subsequent “permanent and transitory components” answers the substantive question better, but the warning about using long-term implications of short-term models remains worthwhile today.
Journal of Economic Dynamics and Control, 12 (June/July 1988) 255-296. (With Argia M. Sbordone). This paper sits halfway between the “random walk in GNP” JPE and “permanent and transitory components” QJE. The “random walk” is univariate. Here, we realized that consumption could tell you a lot about the permanent component of GNP. Here, we use that insight in spectral and variance-ratio calculations. The answers are the same as in “permanent and transitory components”, but I now prefer the simpler VAR treatment in that paper. When GNP or stock prices are cointegrated with a random walk the subtle long-horizon and “nonparametric” techniques needed in the “random walk in GNP” really are no longer needed; short order models to produce good long-term forecasts.
Jan 13 2022. Review of Finance 2021 This is an essay on portfolios, based on a keynote talk at the NBER conference, ``New Developments in Long-Term Asset Management” Jan 21 2021. Read the paper. Slides for the talk