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We characterize the response of U.S., German and British stock, bond and foreign exchange markets to real-time U.S. macroeconomic news. Our analysis is based on a unique data set of high-frequency futures returns for each of the markets. We find that news surprises produce conditional mean jumps; hence high-frequency stock, bond and exchange rate dynamics are linked to fundamentals. The details of the linkages are particularly intriguing as regards equity markets. We show that equity markets react differently to the same news depending on the state of the economy, with bad news having a positive impact during expansions and the traditionally-expected negative impact during recessions. We rationalize this by temporal variation in the competing "cash flow" and "discount rate" effects for equity valuation. This finding helps explain the time-varying correlation between stock and bond returns, and the relatively small equity market news effect when averaged across expansions and recessions. Lastly, relying on the pronounced heteroskedasticity in the high-frequency data, we document important contemporaneous linkages across all markets and countries over-and-above the direct news announcement effects. JEL Klassifikation: F3, F4, G1, C5
Deviations from normality in financial return series have led to the development of alternative portfolio selection models. One such model is the downside risk model, whereby the investor maximizes his return given a downside risk constraint. In this paper we empirically observe the international equity allocation for the downside risk investor using 9 international markets’ returns over the last 34 years. The results are stable for various robustness checks. Investors may think globally, but instead act locally, due to greater downside risk. The results provide an alternative view of the home bias phenomenon, documented in international financial markets. JEL Classification: G11, G12, G15
We test whether asymmetric preferences for losses versus gains as in Ang, Chen, and Xing (2006) also affect the pricing of cash flow versus discount rate news as in Campbell and Vuolteenaho (2004). We construct a new four-fold beta decomposition, distinguishing cash flow and discount rate betas in up and down markets. Using CRSP data over 1963–2008, we find that the downside cash flow beta and downside discount rate beta carry the largest premia. We subject our result to an extensive number of robustness checks. Overall, downside cash flow risk is priced most consistently across different samples, periods, and return decomposition methods, and is the only component of beta that has significant out-of-sample predictive ability. The downside cash flow risk premium is mainly attributable to small stocks. The risk premium for large stocks appears much more driven by a compensation for symmetric, cash flow related risk. Finally, we multiply our premia estimates by average betas to compute the contribution of the different risk components to realized average returns. We find that up and down discount rate components dominate the contribution to average returns of downside cash flow risk. Keywords: Asset Pricing, Beta, Downside Risk, Upside Risk, Cash Flow Risk, Discount Rate Risk JEL Classification: G11, G12, G14
This paper analyzes the equilibrium pricing implications of contagion risk in a two-tree Lucas economy with CRRA preferences. The dividends of both trees are subject to downward jumps. Some of these jumps are contagious and increase the risk of subsequent jumps in both trees for some time interval. We show that contagion risk leads to large price-dividend ratios for small assets, a joint movement of prices in the case of a regime change from the calm to the contagion state, significantly positive correlations between assets, and large positive betas for small assets. Whereas disparities between the assets with respect to their propensity to trigger contagion barely matter for pricing, the prices of robust assets that are hardly affected by contagion and excitable assets that are severely hit by contagion differ significantly. Both in absolute terms and relatively to the market, the price of a small safe haven increases if the economy reaches the contagion state. On the contrary, the price of a small, contagion-sensitive asset exhibits a pronounced downward jump.
With this paper, I propose a simple asset pricing model that accounts for the influence from social interaction. Investors are assumed to make up their mind about an asset’s price based on a forecasting strategy and its past profitability as well as on the contemporaneous expectations of other market participants. Empirically analysing stocks of the DAX30 index, I provide evidence that social interaction rather destabilises financial markets. Based on my results, I state that at least, it does not have a stabilising effect.
With this paper, I propose a simple asset pricing model that accounts for the influence from social interaction. Investors are assumed to make up their mind about an asset's price based on a forecasting strategy and its past profitability as well as on the contemporaneous expectations of other market participants. Empirically analysing stocks in the DAX30 index, I provide evidence that social interaction rather destabilises financial markets. At least, it does not have a stabilising effect.
This paper analyzes the equilibrium pricing implications of contagion risk in a Lucas-tree economy with recursive preferences and jumps. We introduce a new economic channel allowing for the possibility that endowment shocks simultaneously trigger a regime shift to a bad economic state. We document that these contagious jumps have far-reaching asset pricing implications. The risk premium for such shocks is superadditive, i.e. it is 2.5\% larger than the sum of the risk premia for pure endowment shocks and regime switches. Moreover, contagion risk reduces the risk-free rate by around 0.5\%. We also derive semiclosed-form solutions for the wealth-consumption ratio and the price-dividend ratios in an economy with two Lucas trees and analyze cross-sectional effects of contagion risk qualitatively. We find that heterogeneity among the assets with respect to contagion risk can increase risk premia disproportionately. In particular, big assets with a large exposure to contagious shocks carry significantly higher risk premia.
We analyze the implications of the structure of a network for asset prices in a general equilibrium model. Networks are represented via self- and mutually exciting jump processes, and the representative agent has Epstein-Zin preferences. Our approach provides a exible and tractable unifying foundation for asset pricing in networks. The model endogenously generates results in accordance with, e.g., the robust-yetfragile feature of financial networks shown in Acemoglu, Ozdaglar, and Tahbaz-Salehi (2014) and the positive centrality premium documented in Ahern (2013). We also show that models with simpler preference assumptions cannot generate all these findings simultaneously.
There has been a considerable debate about whether disaster models can rationalize the equity premium puzzle. This is because empirically disasters are not single extreme events, but long-lasting periods in which moderate negative consumption growth realizations cluster. Our paper proposes a novel way to explain this stylized fact. By allowing for consumption drops that can spark an economic crisis, we introduce a new economic channel that combines long-run and short-run risk. First, we document that our model can match consumption data of several countries. Second, it generates a large equity risk premium even if consumption drops are of moderate size.