- Production and Endogenous Preferences (2018) Job Market Paper
The standard two-sector equilibrium model with capital accumulation, convex adjustment costs and constant elasticity of substitution is augmented with the endogenous preference evolution mechanism. In the resulting asset pricing model with recursive utility both the distribution of capital and preference evolution determine the sectoral Tobin’s Q, risk premia, investments and the interest rate. The preference evolution is defined by a dividend share and in the limiting case (when there is one sector only) preferences collapse to one good and we are back in the standard production setting. In equilibrium, optimal consumption-investment and optimal preferences are jointly determined in a fixed point problem. In the empirical section the first-order movements in sectoral wealth shares, their relation with sectoral Tobin's Q and risk premia are analyzed in the US data sample over 1952-2016. The US economy is represented by financial and housing sectors. The model is able to generate positive relationship between Tobin's Q and wealth share and negative relationship between risk premia and wealth share as observed in the data.
Low consumption growth tends to occur together with either very high or very low inflation. The probability of low expected consumption growth estimated from a Markov chain for consumption growth and inflation is highly correlated with a measure for the likelihood of consumption disasters suggested by Wachter (2013). A simple asset pricing model with recursive utility and unobservable states reproduces the time variation in volatilities and correlations of stock and bond returns very well. Our findings suggest that the disaster risk paradigm can be extended towards an explanation of the time-varying nature of the stock-bond return correlation when the informational role of inflation is taken into account properly.
Presented at: WFA 2018*, SGF 2018*, German Economists Abroad Conference 2017*, Paris December Finance Meeting/Eurofidai 2017 , DGF 2017 , 7th IWH-INFER AEEP Workshop in Halle , CEPR ESSFM Gerzensee 2017 (evening session)*, 34th AFFI 2017, MFA 2017*, 2017 Colloquium on Financial Markets in Cologne, Wharton*, BI Oslo*, Goethe University Frankfurt, Deutsche Bundesbank*, Swiss National Bank*, Österreichische NationalBank* (*-presented by coauthors)
We propose a 2-country asset-pricing model where agents' preferences change endogenously as a function of the popularity of internationally traded goods. We determine the effect of the time-variation of preferences on equity markets, consumption and portfolio choices. When agents are more sensitive to the popularity of domestic consumption goods, the local stock market reacts more strongly to the preferences of local agents than to the preferences of foreign agents. Therefore, home bias arises because home-country stock represents a better investment opportunity for hedging against future fluctuations in preferences. We test our model and find that preference evolution is a plausible driver of key macroeconomic variables and stock returns.
Presented at: Paris December Finance Meeting/Eurofidai 2018, EEA 2018, 26th Finance Forum*, World Finance Conference 2017*, 34th AFFI 2017, 1st CESC in Barcelona 2017, SGF 2017*, 9th FIW in International Economics (Vienna)*, AFM 2016, DGF 2016*, 2nd Research in Behavioral Finance Conference in Amsterdam*, 13th Workshop on Social Economy for Young Economists in Bologna*, Bank of Lithuania* and University of Zurich* (*-presented by coauthor)
We investigate the stock return predictability for the aggregate Central and Eastern European (CEE) markets from 1998 through the mid 2017. Using the firm-level data we construct country portfolios and sets of component portfolios: 10 industry portfolios, 10 size portfolios, 10 market-to-book portfolios. Predictive regressions with various fundamental variables and technical indicators are conducted. In-sample and out-of-sample tests highlight return predictability across different portfolios. Out-of-sample decomposition of predictability shows that time-varying macroeconomic risk premium can be captured by the conditional CAPM model.
Presented at: Paris Financial Management Conference 2018, WIEM 2018, World Finance & Banking Symposium in Bangkok 2017