93 research outputs found
Predictability of Returns and Cash Flows
We review the literature on return and cash flow growth predictability
form the perspective of the present-value identity. We focus
predominantly on recent work. Our emphasis is on U.S. aggregate stock
return predictability, but we also discuss evidence from other asset
classes and countries
Health and Mortality Delta: Assessing the Welfare Cost of Household Insurance Choice
We develop a pair of risk measures for the universe of health and
longevity products that includes life insurance, annuities, and
supplementary health insurance. Health delta measures the differential
payoff that a policy delivers in poor health, while mortality delta
measures the differential payoff that a policy delivers at death.
Optimal portfolio choice simplifies to the problem of choosing a
combination of health and longevity products that replicates the optimal
exposure to health and mortality delta. For each household in the Health
and Retirement Study, we calculate the health and mortality delta
implied by its ownership of life insurance, annuities including private
pensions, supplementary health insurance, and long-term care insurance.
For the median household aged 51 to 58, the lifetime welfare cost of
market incompleteness and suboptimal portfolio choice is 28 percent of
total wealth
The Cross-Section and Time-Series of Stock and Bond Returns
We propose a three-factor model that jointly prices the cross-section of
returns on portfolios of stocks sorted on the book-to-market dimension,
the cross-section of government bonds sorted by maturity, and time
series variation in expected bond returns. The main insight is that
innovations to the nominal bond risk premium price the book-to-market
sorted stock portfolios. We argue that these innovations capture
business cycle risk and show that dividends of the highest
book-to-market portfolio fall substantially more than those of the low
book-to-market portfolio during NBER recessions. We propose a structural
model that ties together the nominal bond risk premium, the
cross-section of book-to-market sorted stock portfolios, and recessions.
This model is quantitatively consistent with the observed value, equity,
and nominal bond risk premia
Mortgage Timing
We study how the term structure of interest rates relates to mortgage
choice, both at the household and the aggregate level. A simple utility
framework of mortgage choice points to the long-term bond risk premium
as theoretical determinant: when the bond risk premium is high,
fixed-rate mortgage payments are high, making adjustable-rate mortgages
more attractive. This long-term bond risk premium is markedly different
from other term structure variables that have been proposed, including
the yield spread and the long yield. We confirm empirically that the
bulk of the time variation in both aggregate and loan-level mortgage
choice can be explained by time variation in the bond risk premium. This
is true whether bond risk premia are measured using forecasters' data, a
VAR term structure model, or from a simple household decision rule based
on adaptive expectations. This simple rule moves in lock-step with
mortgage choice, lending credibility to a theory of strategic mortgage
timing by households
Predictability of Returns and Cash Flows
We review the literature on return and cash flow growth predictability
form the perspective of the present-value identity. We focus
predominantly on recent work. Our emphasis is on U.S. aggregate stock
return predictability, but we also discuss evidence from other asset
classes and countries
Decentralized Decision Making In Investment Management
The article addresses the investment problem of a pension fund in which a centralized decision maker, the Chief Investment Officer (CIO), employs multiple asset managers to implement investment strategies in separate asset classes. The investment management division of pension funds is typically structured around traditional asset classes such as equities, fixed income, and alternative investments. The asset allocation decisions are made in at least two stages. Firstly, the CIO allocates capital to the different asset classes, each managed by a different asset manager. Secondly, each manager decides how to allocate the funds made available to him, that is, to the assets within his class. The CIO of the fund therefore faces a tradeoff between the benefits of decentralization, driven by the market timing and stock selection skills of the managers, and the costs of delegation and decentralization. The optimal portfolio of the asset managers can be decomposed into two components. The first component is the standard myopic demand that optimally exploits the risk-return trade-off. The second component minimizes the instantaneous return variance and is therefore labeled the minimum-variance portfolio. The minimum variance portfolio substitutes for the riskless asset in the optimal portfolio of the asset manager. The two components are then weighted by the risk attitude of the asset manager to arrive at the optimal portfolio
Long Run Risk, the Wealth-Consumption Ratio, and the Temporal Pricing of Risk
Representative agent consumption based
asset pricing models have made great strides in
accounting for many important features of asset
returns. The long run risk (LRR) models of
Ravi Bansal and Amir Yaron (2004) are a prime
example of this progress. Yet, several other representative
agent models, such as the external
habit model of John Y. Campbell and John H.
Cochrane (1999) and the variable rare disasters
model of Xavier Gabaix (2008), seem to be able
to match a similar set of asset pricing moments.
Additional moments would be useful to help distinguish
between these models. Hanno Lustig,
Stijn Van Nieuwerburgh, and Adrien Verdelhan
(2009) argue that the wealth-consumption ratio
is such a moment. A comparison of the wealthconsumption
ratio in the LRR model and in the
data is favorable to the LRR model. This is no
small feat because the wealth-consumption ratio
is not a target in the usual calibrations of the
model, and the LRR is—so far—the sole model
able to reproduce both the equity premium and
the wealth-consumption ratio. The LRR model
matches the properties of the wealth-consumption
ratio despite the fact that it implies a negative
real bond risk premium. This is because it
generates quite a bit of consumption cash flow
risk to offset the negative discount rate risk
Health and Mortality Delta: Assessing the Welfare Cost of Household Insurance Choice
We develop a pair of risk measures for the universe of health and
longevity products that includes life insurance, annuities, and
supplementary health insurance. Health delta measures the differential
payoff that a policy delivers in poor health, while mortality delta
measures the differential payoff that a policy delivers at death.
Optimal portfolio choice simplifies to the problem of choosing a
combination of health and longevity products that replicates the optimal
exposure to health and mortality delta. For each household in the Health
and Retirement Study, we calculate the health and mortality delta
implied by its ownership of life insurance, annuities including private
pensions, supplementary health insurance, and long-term care insurance.
For the median household aged 51 to 58, the lifetime welfare cost of
market incompleteness and suboptimal portfolio choice is 28 percent of
total wealth
Mortgage Timing
We study how the term structure of interest rates relates to mortgage
choice, both at the household and the aggregate level. A simple utility
framework of mortgage choice points to the long-term bond risk premium
as theoretical determinant: when the bond risk premium is high,
fixed-rate mortgage payments are high, making adjustable-rate mortgages
more attractive. This long-term bond risk premium is markedly different
from other term structure variables that have been proposed, including
the yield spread and the long yield. We confirm empirically that the
bulk of the time variation in both aggregate and loan-level mortgage
choice can be explained by time variation in the bond risk premium. This
is true whether bond risk premia are measured using forecasters' data, a
VAR term structure model, or from a simple household decision rule based
on adaptive expectations. This simple rule moves in lock-step with
mortgage choice, lending credibility to a theory of strategic mortgage
timing by households
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