Research
Solving real business cycle models by solving systems of first order conditions
1993 Set of old lecture notes. Still, underground copies are circulating, so you can get a fresh one here.
1993 Set of old lecture notes. Still, underground copies are circulating, so you can get a fresh one here.
Long term debt and optimal policy in the fiscal theory of the price level
Econometrica 69, 69-116 (2001). The fiscal theory with long term debt, and how to match the fiscal theory with business-cycle variation in debt and inflation. We typically write fiscal theory models with one-period debt, but the maturity structure turns out to matter a lot. For example, if the government pays off a perpetuity, then the price level is determined by the coupon coming due each year and that year’s taxes, with no present value of future taxes. I also resolve the empirical puzzle that inflation and deficits seem not to commove. That’s exactly what we expect of a government that’s trying to smooth inflation in the face of fiscal shocks.
Econometrica 69, 69-116 (2001). The fiscal theory with long term debt, and how to match the fiscal theory with business-cycle variation in debt and inflation. We typically write fiscal theory models with one-period debt, but the maturity structure turns out to matter a lot. For example, if the government pays off a perpetuity, then the price level is determined by the coupon coming due each year and that year’s taxes, with no present value of future taxes. I also resolve the empirical puzzle that inflation and deficits seem not to commove. That’s exactly what we expect of a government that’s trying to smooth inflation in the face of fiscal shocks.
Explaining the Poor Performance of Consumption-Based Asset Pricing Models
(With John Y. Campbell). Journal of Finance 55(6) (December 2000) 2863-2878. The CAPM outperforms the consumption-based model in artificial data from the habit persistence model used in "By force of Habit.."
(With John Y. Campbell). Journal of Finance 55(6) (December 2000) 2863-2878. The CAPM outperforms the consumption-based model in artificial data from the habit persistence model used in "By force of Habit.."
A rehabilitation of stochastic discount factor methodology
Manuscript, July 2000 A short note showing how Kan and Zhou (1999) went wrong. Adapted from comments I gave to Jagannathan and Wang given at the spring 2000 NBER asset pricing meeting. The Journal of Finance does not publish corrections, even to flat-out mistakes, alas.
Manuscript, July 2000 A short note showing how Kan and Zhou (1999) went wrong. Adapted from comments I gave to Jagannathan and Wang given at the spring 2000 NBER asset pricing meeting. The Journal of Finance does not publish corrections, even to flat-out mistakes, alas.
Beyond Arbitrage: Good-Deal Asset Price Bounds in Incomplete Markets
(With Jesus Saa-Requejo.) Journal of Political Economy 108, 79-119, 2000 We add a Sharpe ratio or discount factor volatility constraint to the standard no-arbitrage restriction and obtain useful bounds on option prices in environments that don't allow perfect replication. Most importantly we show how to do this in multiperiod and continuous-time, continuous-trading environments, and there are lots of applications and pretty pictures. Final manuscript with algebra appendix
(With Jesus Saa-Requejo.) Journal of Political Economy 108, 79-119, 2000 We add a Sharpe ratio or discount factor volatility constraint to the standard no-arbitrage restriction and obtain useful bounds on option prices in environments that don't allow perfect replication. Most importantly we show how to do this in multiperiod and continuous-time, continuous-trading environments, and there are lots of applications and pretty pictures. Final manuscript with algebra appendix
Portfolio Advice for a Multifactor World
Economic Perspectives XXIII (3) Third quarter 1999 (Federal Reserve Bank of Chicago), also NBER working paper 7170. This is a review and interpretation of how portfolio theory should adapt in a multifactor, predictable world described in New Facts in Finance. See especially the three dimensional update of the two fund theorem.
Economic Perspectives XXIII (3) Third quarter 1999 (Federal Reserve Bank of Chicago), also NBER working paper 7170. This is a review and interpretation of how portfolio theory should adapt in a multifactor, predictable world described in New Facts in Finance. See especially the three dimensional update of the two fund theorem.
New Facts in Finance
Economic Perspectives XXIII (3) Third quarter 1999 (Federal Reserve Bank of Chicago), also NBER working paper 7169. This is a review essay of the transition from unpredictable returns and CAPM to predictable returns and multifactor models.
Economic Perspectives XXIII (3) Third quarter 1999 (Federal Reserve Bank of Chicago), also NBER working paper 7169. This is a review essay of the transition from unpredictable returns and CAPM to predictable returns and multifactor models.
“By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior”
Journal of Political Economy, 107, 205-251 (April 1999) (With John Y. Campbell) JSTOR Manuscript with extra appendices A utility function with a slow-moving habit generates slow-moving countercyclical risk aversion. In turn this generates time-varying price/dividend ratio that forecasts stock returns, does not forecast dividends, and so forth. Balancing intertemporal substitution with precautionary savings gives a constant interest rate, the usual problem with habit models. The NBER working paper version includes a time-varying interest rate, which also generates yield spreads that forecast bond returns.
Journal of Political Economy, 107, 205-251 (April 1999) (With John Y. Campbell) JSTOR Manuscript with extra appendices A utility function with a slow-moving habit generates slow-moving countercyclical risk aversion. In turn this generates time-varying price/dividend ratio that forecasts stock returns, does not forecast dividends, and so forth. Balancing intertemporal substitution with precautionary savings gives a constant interest rate, the usual problem with habit models. The NBER working paper version includes a time-varying interest rate, which also generates yield spreads that forecast bond returns.
"Good-deal option price bounds with stochastic volatility and stochastic interest rate."
(With Jesus Saa-Requejo) Manuscript Jan 1999 A real continuous-time, two-state variable application of the good deal technology.
(With Jesus Saa-Requejo) Manuscript Jan 1999 A real continuous-time, two-state variable application of the good deal technology.
A Frictionless View of U.S. Inflation
In Ben S. Bernanke and Julio J. Rotemberg, eds., NBER Macroeconomics Annual 1998 Cambridge MA: MIT press, p. 323-384. My first foray into the fiscal theory. It includes a proof that you can't test for regimes -- the government debt valuation equation and the money demand equation hold in both equilibria, and there is no Granger causality prediction. I also explain the intuition of the fiscal theory. The goal was to write a "Fiscal history", to understand the path of US inflation via the fiscal theory. That turns out to be harder than I thought, and is still an ongoing project. Published version (local). Direct link to published version (NBER)
In Ben S. Bernanke and Julio J. Rotemberg, eds., NBER Macroeconomics Annual 1998 Cambridge MA: MIT press, p. 323-384. My first foray into the fiscal theory. It includes a proof that you can't test for regimes -- the government debt valuation equation and the money demand equation hold in both equilibria, and there is no Granger causality prediction. I also explain the intuition of the fiscal theory. The goal was to write a "Fiscal history", to understand the path of US inflation via the fiscal theory. That turns out to be harder than I thought, and is still an ongoing project. Published version (local). Direct link to published version (NBER)
What do the VARs Mean? Measuring the Output Effects of Monetary Policy
Journal of Monetary Economics 41:2 April 1998 277-300 (Revision of NBER WP 5154 June 1995; (Manuscript). Responses to monetary policy shocks seem long and drawn out. Do we need models with extensive frictions? No, because the response of policy to policy shocks is also drawn out. If you allow expected policy to affect output and inflation, you can make sense of drawn out impulse-response functions with a very short structural response, but a long-lasting impulse.
Journal of Monetary Economics 41:2 April 1998 277-300 (Revision of NBER WP 5154 June 1995; (Manuscript). Responses to monetary policy shocks seem long and drawn out. Do we need models with extensive frictions? No, because the response of policy to policy shocks is also drawn out. If you allow expected policy to affect output and inflation, you can make sense of drawn out impulse-response functions with a very short structural response, but a long-lasting impulse.
"Where is the Market Going? Uncertain Facts and Novel Theories"
Economic Perspectives XXI: 6 (November/December) 1997 (Federal Reserve Bank of Chicago), also NBER Working paper 6207. Will stocks average 9% for the next 50 years? The equity premium, return predictability, and a review of theories and facts.
Economic Perspectives XXI: 6 (November/December) 1997 (Federal Reserve Bank of Chicago), also NBER Working paper 6207. Will stocks average 9% for the next 50 years? The equity premium, return predictability, and a review of theories and facts.
“A Cross-Sectional Test of an Investment-Based Asset Pricing Model”
Journal of Political Economy, 104 (June 1996) A factor model with two investment returns (roughly, investment growth) to explain the cross section of stock returns. It is also where I first thought about conditional vs. unconditional models, scaling factors in GMM, and (somewhat dangerous) plots of average returns vs. predicted.
Journal of Political Economy, 104 (June 1996) A factor model with two investment returns (roughly, investment growth) to explain the cross section of stock returns. It is also where I first thought about conditional vs. unconditional models, scaling factors in GMM, and (somewhat dangerous) plots of average returns vs. predicted.
“Time-Consistent Health Insurance”
Journal of Political Economy, 103 (June 1995) 445-473. None of us has health insurance, really. You get sick, you lose your job or get divorced, and now you have a preexisting condition. This paper shows how to implement “premium increase insurance” that gets around the problem. If you get sick, you get a lump sum that allows you to pay higher insurance premiums. It allows a private-market solution to the main problem of health insurance attracting regulation.
Journal of Political Economy, 103 (June 1995) 445-473. None of us has health insurance, really. You get sick, you lose your job or get divorced, and now you have a preexisting condition. This paper shows how to implement “premium increase insurance” that gets around the problem. If you get sick, you get a lump sum that allows you to pay higher insurance premiums. It allows a private-market solution to the main problem of health insurance attracting regulation.
“Shocks”
Carnegie-Rochester Conference Series on Public Policy 41, (December 1994) 295-364. A comprehensive look at which shocks matter and which don’t, including technology, money, oil and credit. None of the above accounts for much of economic fluctuations or inflation. Monetary policy shocks in particular account for very little output fluctuation and zero inflation variation. “Consumption” shocks, reflecting information agents see but we do not see do a pretty good job, but are harder to integrate into economic theory.
Carnegie-Rochester Conference Series on Public Policy 41, (December 1994) 295-364. A comprehensive look at which shocks matter and which don’t, including technology, money, oil and credit. None of the above accounts for much of economic fluctuations or inflation. Monetary policy shocks in particular account for very little output fluctuation and zero inflation variation. “Consumption” shocks, reflecting information agents see but we do not see do a pretty good job, but are harder to integrate into economic theory.
Permanent and Transitory Components of GNP and Stock Prices
Quarterly Journal of Economics CIX (February 1994) 241-266. This is my favorite solution to the permanent/transitory decomposition issue for GNP and stock prices. I use bivariate autoregressions of consumption and GNP, and of dividends and stock prices. Consumption and dividend growth are unpredictable, so act as stochastic trends for GNP and stock prices. A movement in stock prices with no current change in dividends is completely transitory, so can be labeled an “expected return” shock. A movement in stock prices with a change in dividends is permanent and so is a “permanent earnings” shock. Note the QJE switched Figure II and III.
Quarterly Journal of Economics CIX (February 1994) 241-266. This is my favorite solution to the permanent/transitory decomposition issue for GNP and stock prices. I use bivariate autoregressions of consumption and GNP, and of dividends and stock prices. Consumption and dividend growth are unpredictable, so act as stochastic trends for GNP and stock prices. A movement in stock prices with no current change in dividends is completely transitory, so can be labeled an “expected return” shock. A movement in stock prices with a change in dividends is permanent and so is a “permanent earnings” shock. Note the QJE switched Figure II and III.
Rethinking Production Under Uncertainty
Manuscript 1993. Standard production technologies y(t) = shock(t) f(k) allow transformation across time but not across states of nature. Hence, the marginal rates of transformation needed to construct a true “production based asset pricing model” are undefined. This paper starts to think about how one might sensibly construct a technology that allows producers to transform goods across states of nature, and hence to construct a real “production-based” model, independent of preferences. Also did not result in a published paper, as I got stuck on an identification problem.
Manuscript 1993. Standard production technologies y(t) = shock(t) f(k) allow transformation across time but not across states of nature. Hence, the marginal rates of transformation needed to construct a true “production based asset pricing model” are undefined. This paper starts to think about how one might sensibly construct a technology that allows producers to transform goods across states of nature, and hence to construct a real “production-based” model, independent of preferences. Also did not result in a published paper, as I got stuck on an identification problem.
“Explaining the Variance of Price-Dividend Ratios”
Review of Financial Studies (1992) 5:2, 243-280 Variance of p/d = its ability to forecast returns + its ability to forecast dividend growth. It’s all the former, none the latter. The paper includes an alternative to Campbell-Shiller decomposition, and discount factor bounds coming from price-dividend moments.
Review of Financial Studies (1992) 5:2, 243-280 Variance of p/d = its ability to forecast returns + its ability to forecast dividend growth. It’s all the former, none the latter. The paper includes an alternative to Campbell-Shiller decomposition, and discount factor bounds coming from price-dividend moments.
“Asset Pricing Explorations for Macroeconomics”
1992 NBER Macroeconomics Annual 115-165. (With Lars Peter Hansen) Many variations on Hansen-Jagannathan bounds, including bounds that reflect the low correlation of consumption growth with asset returns, and bounds that reveal interest rate variation by variation in the conditional mean discount factor. A plea to take macro-finance seriously, aimed both at macro and finance audiences. It’s the only way to tell or even define if prices are “rational”, and what else sets marginal rates of transformation to marginal rates of substitution?
1992 NBER Macroeconomics Annual 115-165. (With Lars Peter Hansen) Many variations on Hansen-Jagannathan bounds, including bounds that reflect the low correlation of consumption growth with asset returns, and bounds that reveal interest rate variation by variation in the conditional mean discount factor. A plea to take macro-finance seriously, aimed both at macro and finance audiences. It’s the only way to tell or even define if prices are “rational”, and what else sets marginal rates of transformation to marginal rates of substitution?
A Simple Test of Consumption Insurance
Journal of Political Economy 99:5 (October 1991) 957-976. Are consumers effectively insured against idiosyncratic shocks, either by formal institutions such as charities, private insurance, government programs, or by informal mechanisms such as gifts and “loans” from relatives, friends and neighbors? I test for insurance using regressions of consumption growth on exogenous variables. Thinking through the specification of the regressions is not easy. I reject full insurance for long illness and involuntary job loss, but not for spells of unemployment, loss of work due to a strike and an involuntary move.
Journal of Political Economy 99:5 (October 1991) 957-976. Are consumers effectively insured against idiosyncratic shocks, either by formal institutions such as charities, private insurance, government programs, or by informal mechanisms such as gifts and “loans” from relatives, friends and neighbors? I test for insurance using regressions of consumption growth on exogenous variables. Thinking through the specification of the regressions is not easy. I reject full insurance for long illness and involuntary job loss, but not for spells of unemployment, loss of work due to a strike and an involuntary move.