Does Firm Value Move Too Much to be Justified by Subsequent Changes in Cash Flow?

The appropriate measure of cash flow for valuing corporate assets is net payout, which is the sum of dividends, interest, and net repurchases of equity and debt. Variation in net payout yield, the ratio of net payout to asset value, is mostly driven by movements in expected cash flow growth, instead of movements in discount rates. Net payout yield is less persistent than dividend yield and implies much smaller variation in long-horizon discount rates. Therefore, movements in the value of corporate assets can be justified by changes in expected future cash flow.

Does School Quality Matter? Returns to Education and the Characteristics of Schools in South Africa

This paper contributes to what is known about the impact of school quality, by documenting its effect on the incomes of Black South Africans, using data from the 1996 South African census and two national surveys of school quality. South Africa provides an interesting laboratory for studying the impact of school quality on labor market outcomes. Under the Apartheid system, Blacks faced extremely limited residential and school choices, which limits the extent to which results are attributable to the endogeneity of school and residential choice. In addition, Black schools' funding and staffing decisions were made rather arbitrarily by a White government that was at best indifferent to the needs of Black schools. Large differences in pupil/teacher ratios developed between Black schools, differences much larger than those observed in the United States. Using a two-state estimation procedure similar to that employed by Card and Krueger (1992) and by Heckman et al. (1996), we find that the quality of schools in a respondent's magisterial district of origin has a large and significant effect on the rate of return to schooling for Black men. The South African results are notable, moreover, because they are so similar to those estimated by Card and Krueger (1992) for the United States.

What Does Futures Market Interest Tell Us about the Macroeconomy and Asset Prices?

Economists have traditionally viewed futures prices as fully informative about future economic activity and asset prices. We argue that open interest could be more informative than futures prices in the presence of hedging demand and limited risk absorption capacity in futures markets. We find that movements in open interest are highly pro-cyclical, correlated with both macroeconomic activity and movements in asset prices. Movements in commodity market interest predict commodity returns, bond returns, and movements in the short rate even after controlling for other known predictors. To a lesser degree, movements in open interest predict returns in currency, bond, and stock markets.

Asset Prices Under Habit Formation and Reference-Dependent Preferences

This article explains the high level and the countercyclical variation of the equity premium in a consumption-based asset pricing model with low large-scale risk aversion. Investors have gain-loss utility over consumption relative to slowly time-varying habit. Stocks deliver low returns in recessions when consumption falls below habit; investors therefore require a high premium for holding stocks. The model\u27s conditional moment restrictions are tested on consumption and asset returns data. The empirical estimate of large-scale risk aversion is low, whereas the estimate of loss aversion agrees with prior experimental evidence

Measuring Business Cycles: A Wavelet Analysis of Economic Time Series

Multiresolution wavelet analysis is a natural way to decompose an economic time series into trend, cycle, and noise. The method is illustrated with GDP data. The business-cycle component of the wavelet-filtered series closely resembles the series filtered by the approximate bandpass filter

Portfolio Choice in Retirement: Health Risk and the Demand for Annuities, Housing, and Risky Assets

This paper develops a consumption and portfolio-choice model of a retiree who allocates wealth in four asset classes: a riskless bond, a risky asset, a real annuity, and housing. The retiree chooses health expenditure endogenously in response to stochastic depreciation of health. The model is calibrated to explain the joint dynamics of health expenditure, health, and asset allocation for retirees in the Health and Retirement Study, aged 65 and older. The calibrated model is used to assess the welfare gain from private annuitization. The welfare gain ranges from 13 percent of wealth at age 65 for those in worst health, to 18 percent for those in best health

Efficient Tests of Stock Return Predictability

Empirical studies have suggested that stock returns can be predicted by ï¬nancial variables such as the dividend-price ratio. However, these studies typically ignore the high persistence of predictor variables, which can make ï¬rst-order asymptotics a poor approximation in ï¬nite samples. Using a more accurate asymptotic approximation, we propose two methods to deal with the persistence problem. First, we develop a pretest that determines when the conventional t-test for predictability is misleading. Second, we develop a new test of predictability that results in correct inference regardless of the degree of persistence and is efficient compared to existing methods. Applying our methods to US data, we ï¬nd that the dividend-price ratio and the smoothed earningsprice ratio are sufficiently persistent for conventional inference to be highly misleading. However, we ï¬nd some evidence for predictability using our test, particularly with the earnings-price ratio. We also ï¬nd evidence for predictability with the short-term interest rate and the long-short yield spread, for which the conventional t-test leads to correct inference.

Testing for Weak Instruments in Linear IV Regression

Weak instruments can produce biased IV estimators and hypothesis tests with large size distortions. But what, precisely, are weak instruments, and how does one detect them in practice? This paper proposes quantitative definitions of weak instruments based on the maximum IV estimator bias, or the maximum Wald test size distortion, when there are multiple endogenous regressors. We tabulate critical values that enable using the first-stage F-statistic (or, when there are multiple endogenous regressors, the Cragg-Donald (1993) statistic) to test whether given instruments are weak. A technical contribution is to justify sequential asymptotic approximations for IV statistics with many weak instruments.

Efficient Tests of Stock Return Predictability

Conventional tests of the predictability of stock returns could be invalid, that is reject the null too frequently, when the predictor variable is persistent and its innovations are highly correlated with returns. We develop a pretest to determine whether the conventional t-test leads to invalid inference and an efficient test of predictability that corrects this problem. Although the conventional t-test is invalid for the dividend-price and smoothed earnings-price ratios, our test finds evidence for predictability. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to valid inference.

Portfolio Choice in Retirement: Health Risk and the Demand for Annuities, Housing, and Risky Assets

This paper develops a life-cycle model in which a household faces stochastic health depreciation and chooses consumption, health expenditure, and the allocation of its wealth between bonds, stocks, and housing. The model is calibrated to explain the cross-sectional variation and the joint dynamics of health expenditure, health, and wealth for females, aged 65 or older, in the Health and Retirement Study. The calibrated model implies that the welfare gain from relaxing borrowing constraints on home equity is 5 percent of wealth at age 65. Similarly, the welfare gain from private annuitization is 16 percent of wealth at age 65.