Asset pricing with idiosyncratic risk and overlapping generations

A number of existing studies have concluded that risk sharing allocations supported by competitive, incomplete markets equilibria are quantitatively close to first-best. Equilibrium asset prices in these models have been difficult to distinguish from those associated with a complete markets model, the counterfactual features of which have been widely documented. This paper asks if life cycle considerations, in conjunction with persistent idiosyncratic shocks which become more volatile during aggregate downturns, can reconcile the quantitative properties of the competitive asset pricing framework with those of observed asset returns. We begin by arguing that data from the Panel Study on Income Dynamics support the plausibility of such a shock process. Our estimates suggest a high degree of persistence as well as a substantial increase in idiosyncratic conditional volatility coincident with periods of low growth in U.S. GNP. When these factors are incorporated in a stationary overlapping generations framework, the implications for the returns on risky assets are substantial. Plausible parameterizations of our economy are able to generate Sharpe ratios which match those observed in U.S. data. Our economy cannot, however, account for the level of variability of stock returns, owing in large part to the specification of its production technology.Finance, OLG

Price dispersion: The role of distance, borders and location

We study deviations from the Law-of-One-Price using microeconomic data on the retail prices of approximately 220 individual goods and services across 122 cities located in 79 countries over the period from 1990 to 2000.

Intergenerational Mobility and the Informative Content of Surnames

We propose an alternative method for measuring intergenerational mobility. Traditional methods based on panel data provide measurements that are scarce, difficult to compare across countries and almost impossible to get across time. In particular this means that we do not know how intergenerational mobility is correlated with growth, income or the degree of inequality. Our proposal is to measure the informative content of surnames in one census. The more information does the surname have on the income of an individual, the more important is background in determining outcomes; and thus, the less mobility there is. The reason for this is that surnames inform on family relationships because the distribution of surnames is necessarily much skewed. A large percentage of the population is bound to have a very unfrequent surname. For them the partition generated by surnames is very informative on family linkages. First, we develop a model whose endogenous variable is the joint distribution of surnames and income. Then we explore the relationship between mobility and the informative content of surnames. We allow for assortative mating to be a determinant of both. Then, we use our methodology to show that in a large Spanish region the informative content of surnames is large and consistent with the model. We also show that it has increased over time, indicating a substantial drop in the degree of mobility. Finally, using the peculiarities of the Spanish surname convention we show that the degree of assortative mating has also increased over time, in such a manner that might explain the decrease in mobility observed. Our method allows us to provide measures of mobility comparable across time. It should also allow us to study other issues related to inheritance.inheritance, birth-death processes, cross-sectional data, population genetics

Asset pricing with idiosyncratic risk and overlapping generations

A number of existing studies have concluded that risk sharing allocations supported by competitive, incomplete markets equilibria are quantitatively close to first-best. Equilibrium asset prices in these models have been difficult to distinguish from those associated with a complete markets model, the counterfactual features of which have been widely documented. This paper asks if life cycle considerations, in conjunction with persistent idiosyncratic shocks which become more volatile during aggregate downturns, can reconcile the quantitative properties of the competitive asset pricing framework with those of observed asset returns. We begin by arguing that data from the Panel Study on Income Dynamics support the plausibility of such a shock process. Our estimates suggest a high degree of persistence as well as a substantial increase in idiosyncratic conditional volatility coincident with periods of low growth in U.S. GNP. When these factors are incorporated in a stationary overlapping generations framework, the implications for the return on risky assets are substantial, however not on the order of magnitude required to generate the average equity premium observed on the U.S. stock market. The largest Sharpe ratio our economies can support is roughly 16\%, whereas that associated with the overall sample from the \citeasnoun{Mehra-Prescott-85} data set is 37\%.

The names in Spain are mainly not in vain: Intergenerational mobility and the informational content of surnames

The paper presents a (genetic) model of the joint distribution of surnames and income. It shows that we can infer how important background is by looking at how informative surnames are. Extensions of the model allow for the possibility of assortative mating, and the introduction of ethnic differences in the income process (due to discrimination or any other reason).This paper was presented at the launch of SIRE, November 2007 and has also been published as CEPR Discussion Paper Number 81

Consumption and Risk Sharing Over the Life Cycle

A striking feature of U.S. data on income and consumption is that inequality increases with age. Using both panel data and an equilibrium life cycle model, we argue that this is informative for understanding the importance and the characteristics of idiosyncratic labor market risk. We find that uncertainty distributed throughout the working years accounts for 40 percent of life time uncertainty, with the remainder being realized prior to entering the labor market. We estimate that the shocks received over the life cycle contain a highly persistent component, with an autocorrelation coefficient between 0.98 and unity. The joint behavior of earnings and consumption inequality, interpreted using our model, adds to the body of evidence suggesting that labor market risks are imperfectly pooled and that a precautionary motive is an important aspect of U.S. savings behavior. The restrictions imposed by general equilibrium theory play an important role in arriving at each of these conclusions.

Intergenerational Mobility and the Informative Content of Surnames

We propose a new methodology for measuring intergenerational mobility in economic wellbeing. Our method is based on the joint distribution of surnames and economic outcomes. It circumvents the need for intergenerational panel data, a long-standing stumbling block for understanding mobility. A single cross-sectional dataset is su cient. Our main idea is simple. If `inheritance' is important for economic outcomes, then rare surnames should predict economic outcomes in the cross-section. This is because rare surnames are indicative of familial linkages. Of course, if the number of rare surnames is small, this won't work. But rare surnames are abundant in the highly-skewed nature of surname distributions from most Western societies. We develop a model that articulates this idea and shows that the more important is inheritance, the more informative will be surnames. This result is robust to a variety of di erent assumptions about fertility and mating. We apply our method using the 2001 census from Catalonia, a large region of Spain. We use educational attainment as a proxy for overall economic well-being. Our main nding is that mobility has decreased among the di erent generations of the 20th century. A complementary analysis based on sibling correlations con rms our results and provides a robustness check on our method. Our model and our data allow us to examine one possible explanation for the observed decrease in mobility. We nd that the degree of assortative mating has increased over time. Overall, we argue that our method has promise because it can tap the vast mines of census data that are available in a heretofore unexploited manner

Affine Models of Currency Pricing

Perhaps the most puzzling feature of currency prices is the tendency for high interest rate currencies to appreciate when the expectations hypothesis suggests the reverse. Some have attributed this forward premium anomaly to a time-varying risk premium but theory has been largely unsuccessful in producing a risk premium with the requisite properties. We characterize the risk premium in a general arbitrage-free setting and describe the features a theory must have to account for the anomaly. In affine models the anomaly requires either that state variables have asymmetric effects on state prices in different currencies or that we abandon the common requirement that interest rates be strictly positive

Affine Models of Currency Pricing

Perhaps the most puzzling feature of currency prices is the tendency for high interest rate currencies to appreciate when the expectations hypothesis suggests the reverse. Some have attributed this forward premium anomaly to a time-varying risk premium but theory has been largely unsuccessful in producing a risk premium with the requisite properties. We characterize the risk premium in a general arbitrage-free setting and describe the features a theory must have to account for the anomaly. In affine models the anomaly requires either that state variables have asymmetric effects on state prices in different currencies or that we abandon the common requirement that interest rates be strictly positive