Not so fast: High-frequency financial data for macroeconomic event studies

Over the last decade, it has become increasingly popular to use event studies with intraday asset pricing data to study the effect of macroeconomic events on the economy. The proponents of this approach argue that asset prices react to macroeconomic events very quickly and that if we know the precise timing of a macroeconomic announcement, a very narrow event window around such an announcement (ranging from 30 minutes to 60 minutes) should be sufficiently long and free from contaminating information that might otherwise cause biased estimates in wider event windows. In contrast, this paper argues that even narrow event windows can lack clean identification because the reaction of asset prices may be affected by other important news that comes out earlier on the same day. We support this argument by studying the relationship between federal funds futures and other asset prices (stocks and Treasuries) on FOMC announcement dates, a relationship widely studied in high-frequency event studies to identify the effect of conventional monetary policy shocks on asset prices. We find that asset prices react significantly more strongly to monetary policy shocks on FOMC announcement dates that overlap with other macroeconomic announcements that come out earlier on the same day. We also find a stronger reaction of asset prices when markets are more volatile. This finding suggests that limitations of investors, such as through rational inattention or asymmetric information, might matter in these event studies. Consequently, one should be cautious before arguing that high-frequency (intraday) event studies adequately address the contamination issues that plague the methods that use low-frequency data

On the distribution of college dropouts: Household wealth and uninsurable idiosyncratic risk

This paper presents a dynamic model of the decision to pursue a college education in which students face uncertainty about their future income stream after graduation due to unobserved heterogeneity in their innate scholastic ability. After students matriculate and start taking exams, they reevaluate their expectations about succeeding in college and may find it optimal to drop out and join the workforce without completing an undergraduate degree. The model shows that, in accordance with the data, poorer students are less likely to graduate and are more apt to drop out earlier than are wealthier students. Our model generates these results without introducing credit constraints. Conditioning on measures of innate ability, in the data we find that poor students are at least 27 percent more likely to drop out of college and they do so sooner than wealthier students

Self-employment in the global economy

This paper studies the eff ects of foreign competition on self-employment levels. We begin by pointing out a previously unknown fact: the greater the exposure to foreign competition, the smaller the fraction of self-employed people. This fact holds across very different countries, across relatively similar countries like European Union members, and across industries within the United States. We develop a model where heterogeneous agents select themselves into being either employees or self-employed in the spirit of Lucas (1978). This, in turn, translates into intra-industry firm heterogeneity as in Melitz (2003). Self-employed agents (firms) can also decide to enter into the export markets, subject to fixed and variable trade costs. The model delivers three basic predictions: (1) domestic self-employment increases with the trade costs of exporting from a foreign country to the home country, (2) domestic self-employment increases with the trade costs of exporting to the foreign country, and (3) higher levels of self-employment are associated with a lower fraction of exporting firms. Our empirical work on inter-industry data for the United States confirms these predictions of the model

Monetary Policy through Production Networks: Evidence from the Stock Market

Monetary policy shocks have a large impact on aggregate stock market returns in narrow event windows around press releases by the Federal Open Market Committee. We use spatial autoregressions to decompose the overall effect of monetary policy shocks into a direct (demand) effect and an indirect (network) effect. We attribute 50%-85% of the overall effect to indirect effects. The decomposition is robust to different sample periods, event windows, and types of announcements. Direct effects are larger for industries selling most of the industry output to end-consumers compared to other industries. We find similar evidence of large indirect effects using ex-post realized cash-flow fundamentals. A simple model with intermediate inputs guides our empirical methodology. Our findings indicate that production networks might be an important propagation mechanism of monetary policy to the real economy

Financial Leverage, Corporate Investment and Stock Returns

This paper presents a dynamic model of the …rm with risk-free debt contracts and capital and debt adjustment costs. The model …ts several stylized facts of corporate …nance and asset pricing: First, book leverage is constant across di¤erent book-to-market portfolios whereas market leverage di¤ers signi…cantly. Second, changes in the market leverage are mainly caused by changes in stock prices rather than changes in debt. Third, when the model is calibrated to …t the cross-sectional distribution of book-to-market ratios it explains the return di¤erences across di¤erent …rms. The model also shows that investment irreversibility alone cannot generate the cross-sectional patterns in stock returns, which opposes the wisdom in the recent literature.

On the Distribution of College Dropouts: Wealth and Uninsurable Idiosyncratic Risk

We present a dynamic model of college education where the students face uncertainty about their income stream after graduation due to unobserved heterogeneity in their innate scholastic ability. As students write exams, they reevaluate their expectations and may find it optimal to drop out and join the workforce without reaping the whole benefit of college education. The model shows that, in accordance with the data, poorer students are less likely to graduate and are more likely to drop out earlier than wealthier students. Our model generates these results without introducing credit constraints. Conditioning on measures of innate ability, we find in the data that poor students are at least 31 % more likely to drop and they do so around a year before rich students. ∗We thank Andrea Pozzi. We also benefited from comments by seminar participants at the Federal Reserve Bank of Boston. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Boston or the Federal Reserve System. Sarojini Rao provided excellent research Around 40 % of every cohort that enrolls in 4-year U.S. colleges drops out and there is a highe

The Distress Premium Puzzle

Fama and French (1992) suggest that the positive value premium results from risk of financial distress. However, recent empirical research has found that financially distressed firms have lower stock returns, using empirical estimates of default probabilities. This paper reconciles the positive value premium and the negative distress premium in a model that decouples actual and risk-neutral default probabilities. Moreover, in agreement with the data, firms with higher bond yields have higher stock returns in the model. The model also captures the fact that book-to-market value dominates financial leverage in explaining stock returns. Finally, the model predicts that firms with higher risk-neutral default probabilities should have higher stock returns, a hypothesis that can be tested using credit default swap premiums

Financial leverage, corporate investment, and stock returns

This paper presents a dynamic model of the firm with risk-free debt contracts, investment irreversibility, and debt restructuring costs. The model fits several stylized facts of corporate finance and asset pricing: First, book leverage is constant across different book-to-market portfolios, whereas market leverage differs significantly. Second, changes in market leverage are mainly caused by changes in stock prices rather than by changes in debt. Third, when the model is calibrated to fit the cross-sectional distribution of book-to-market ratios, it explains the return differences across different firms. The model also shows that investment irreversibility alone cannot generate the cross-sectional patterns observed in stock returns and that leverage is the main source of the value premium.Corporations - Finance ; Stocks - Rate of return

The distress premium puzzle

Fama and French (1992) suggest that the positive value premium results from risk of financial distress. However, recent empirical research has found that financially distressed firms have lower stock returns, using empirical estimates of default probabilities. This paper reconciles the positive value premium and the negative distress premium in a model that decouples actual and risk-neutral default probabilities. Moreover, in agreement with the data, firms with higher bond yields have higher stock returns in the model. The model also captures the fact that book-to-market value dominates financial leverage in explaining stock returns. Finally, the model predicts that firms with higher risk-neutral default probabilities should have higher stock returns, a hypothesis that can be tested using credit default swap premiums.Corporations - Finance ; Default (Finance)