Mortgage Timing

The fraction of newly-originated mortgages that are of the adjustable-rate (ARM) versus the fixed-rate (FRM) type exhibits a surprising amount of time variation. A simple utility framework of mortgage choice points to the bond risk premium as theoretical determinant: when the bond risk premium is high, FRM payments are high, making ARMs more attractive. We confirm empirically that the bulk of the time variation in household mortgage choice can be explained by time variation in the bond risk premium. This is true regardless of whether bond risk premia are measured using forecasters' data, a VAR term structure model, or a simple rule-of-thumb based on adaptive expectations. This simple rule-of-thumb moves in lock-step with mortgage choice, thereby lending further credibility to a theory of strategic mortgage timing by households.

Optimal Decentralized Investment Management

We study a decentralized investment problem in which a CIO employs multiple asset managers to implement and execute investment strategies in separate asset classes. The CIO allocates capital to the managers who, in turn, allocate these funds to the assets in their asset class. This two-step investment process causes several misalignments of objectives between the CIO and his managers and can lead to large utility costs on the part of the CIO. We focus on i) loss of diversification ii) different appetites for risk, iii) different investment horizons, and iv) the presence of liabilities. We derive an optimal unconditional linear performance benchmark and show that this benchmark can be used to better align incentives within the firm. The optimal benchmark substantially mitigates the utility costs of decentralized investment management. These costs can be further reduced when the CIO can screen asset managers on the basis of their risk appetites. Each manager%u2019s optimal level of risk aversion depends on the asset class he manages and can differ substantially from the CIO%u2019s level of risk aversion.

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.

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

Equity Yields

We study a new data set of prices of traded dividends with maturities up to 10 years across three world regions: the US, Europe, and Japan. We use these asset prices to construct equity yields, analogous to bond yields. We decompose these yields to obtain a term structure of expected dividend growth rates and a term structure of risk premia, which allows us to decompose the equity risk premium by maturity. We find that both expected dividend growth rates and risk premia exhibit substantial variation over time, particularly for short maturities. In addition to predicting dividend growth, equity yields help predict other measures of economic growth such as consumption growth. We relate the dynamics of growth expectations to recent events such as the financial crisis and the earthquake in Japan.

Predictive Regressions: A Present-value Approach

We propose a latent variables approach within a present-value model to estimate the expected returns and expected dividend growth rates of the aggregate stock market. This approach aggregates information contained in the history of price-dividend ratios and dividend growth rates to predict future returns and dividend growth rates. We find that returns and dividend growth rates are predictable with R-squared values ranging from 8.2% to 8.9% for returns and 13.9% to 31.6% for dividend growth rates. Both expected returns and expected dividend growth rates have a persistent component, but expected returns are more persistent than expected dividend growth rates.

Mortgage Timing

Mortgages can be broadly classified into adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs). We document a surprising amount of time variation in the fraction of newly-originated mortgages that are of either type in the US and UK. A simple utility framework points to the importance of term structure variables in explaining this variation. In particular, the inflation risk premium, real interest rate risk premium and both the real rate and expected inflation volatility arise as potential determinants. We use a flexible VAR-model to measure these four term structure variables and show that they account for the bulk of variation in the ARM share. Risk premia alone explain sixty percent of the time variation in mortgage choice. Other term structure variables, such as the yield spread, seem only weakly related to the ARM share. We uncover interesting differences between the US and the UK. In the US, the inflation risk premium is most strongly related to the ARM share, while in the UK it is the real rate risk premium. In the US, FRMs contain a prepayment option. We analyze the impact of the prepayment option on optimal mortgage choice

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 Term Structure of Interest Rates in a DSGE Model with Recursive Preferences

We solve a dynamic stochastic general equilibrium (DSGE) model in which the representative household has Epstein and Zin recursive preferences. The parameters governing preferences and technology are estimated by means of maximum likelihood using macroeconomic data and asset prices, with a particular focus on the term structure of interest rates. We estimate a large risk aversion, an elasticity of intertemporal substitution higher than one, and substantial adjustment costs. Furthermore, we identify the tensions within the model by estimating it on subsets of these data. We conclude by pointing out potential extensions that might improve the model’s fit.DSGE models, Epstein-Zin preferences, likelihood estimation, yield curve

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