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Accepted at the
Journal of Financial Economics International panel of estimated crisis probabilities (1876-2020, 42 countries): here . |
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This paper estimates consumption and GDP tail risk dynamics over the long run (1876-2020).
Our predictive approach circumvents the scarcity of large macroeconomic crises by
exploiting a rich information set covering 42 countries. This flexible approach does not
require asset price information and can thus serve as a benchmark to evaluate the empirical
validity of rare disasters models. Our estimates covary with asset prices and forecast future
stock returns, in line with theory. A calibration disciplined by our estimates supports the
prediction that macroeconomic tail risk drives the equity premium.
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Journal of Financial Economics 132(3), 182-204, 2019. |
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The term structure of equity risk has been documented to be downward-sloping. We
capture this feature using return dynamics driven by both a transitory and a permanent
component. We study the asset allocation and portfolio performance when transitory
and permanent components cannot be observed, and therefore need to be estimated.
Both in-sample and out-of-sample, strategies that account for the observed shape of
the term structure of equity risk significantly outperform those which do not. Indeed,
certainty equivalent returns are about 20% larger because properly modeling the timing
of risk implies surges in portfolio returns.
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Journal of Finance 72(5), 2073-2130, 2017. |
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Output, wages and dividends feature term-structures of variance-ratios
respectively flat, increasing and decreasing.
Income insurance from shareholders to workers empirically and theoretically explains these
term-structures. Risk sharing smooths wages but only concerns transitory risk and, hence,
enhances the short-run dividend risk.
A simple general equilibrium model, where labor rigidity affects dividend dynamics and the
price of short-run risk, reconciles standard asset pricing facts with the term-structures of
equity premium and volatility and those of macroeconomic variables, at odds in leading models.
Consistently, actual labor-share variation largely forecasts dividend strips risk, premium and
slope.
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Journal of Financial Economics 122(1), 116-134, 2016. |
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Recent empirical findings document downward-sloping term-structures of equity volatility and risk premia.
An equilibrium model with rare disasters followed by recovery helps reconcile theory with empirical
observations. While previous models focus on frequency and size of disasters, we show that recovery from
disasters, a feature of the data, is at least as important. Indeed, recoveries outweigh the upward-sloping
effect of time-varying disaster intensity, generating downward-sloping term-structures of dividend risk,
equity risk, and equity risk premia. The model quantitatively reconciles a high equity premium and a low
risk-free rate with downward-sloping term-structures, which are at odds in standard frameworks.
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| Corporate Fraction and the Equilibrium Term Structure of Equity Risk |
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Review of Finance 20(2), 855-905, 2016. |
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Leading asset pricing models are inconsistent with the recent empirical evidence of a downward sloping term structure
of equity risk in the short-run. This paper first analytically characterizes conditions under which a continuous-time
long-run risk model can accommodate the stylized facts about the term structures of dividend and equity risk, as
long as dividends are a stochastic fraction of aggregate consumption. Such a co-integrating relation makes dividends
riskier in the short-run than at medium horizons but also preserves the role of long-run risk. Consequently, the
model captures both the traditional puzzles, like the high equity premium, as well as the new evidence about the
term structure of equity risk. |
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Quantitative Finance 14(8), 1383-1398, 2014. |
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| In this work we propose a new and general approach to build dependence in multivariate Lévy processes. We fully characterize a multivariate Lévy process whose margins are able to approximate any Lévy type. Dependence is generated by one or more common sources of jump intensity separately in jumps of any sign and size and a parsimonious method to determine the expositions to these common factors is proposed. Such a new approach allows to calibrate any smooth transition between independence and a large amount of linear dependence and provides higher flexibility in calibrating nonlinear dependence than in other comparable Lévy models in literature. The model is very tractable and a straightforward multivariate simulation procedure is available. An empirical analysis shows a very accurate multivariate fit of stock returns in terms of both linear and nonlinear dependence. |
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International Journal of Theoretical and Applied Finance,
15(4), 2012. |
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In this work we propose a new approach to build multivariate pure jump processes. We introduce linear and nonlinear
dependence, without restrictions on marginal properties, by imposing a multi-factorial structure separately on both
positive and negative jumps. Such a new approach provides higher flexibility in calibrating nonlinear dependence
than in other comparable Lévy models in the literature. Using the notion of multivariate subordinator, this
modeling approach can be applied to the class of univariate Lévy processes which can be written as the
difference of two subordinators. A common example in the financial literature is the variance gamma process, which
we extend to the multivariate (multi-factorial) case. The model is tractable and a straightforward multivariate
simulation procedure is available. An empirical analysis documents an accurate multivariate fit of stock index
returns in terms of both linear and nonlinear dependence. An example of multi-asset option pricing emphasizes the
importance of the proposed multivariate approach. |
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Quantitative Finance, 12(1), 75-87, 2012. |
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| In this work we propose a new multivariate pure jump model. We fully characterize a multivariate Lévy process with finite- and infinite- activity components in positive and negative jumps. This process generalizes the variance gamma one, featuring a "stochastic volatility" effect due to Poisson randomized intensities of positive and negative gamma jumps. Linear and nonlinear dependence is introduced, without restrictions on marginal properties, separately on both positive and negative jumps and on both finite- and infinite- activity ones. Such a new approach provides higher flexibility in calibrating nonlinear dependence than in other comparable Lévy models in literature. The model is very tractable and a straightforward multivariate simulation procedure is available. An empirical analysis shows an almost perfect fit of option prices across a span of moneyness and maturities and a very accurate multivariate fit of stock returns in terms of both linear and nonlinear dependence. A sensitivity analysis of multi-asset option prices emphasizes the importance of the proposed new approach for modeling dependence. |
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This paper empirically documents that expected growth volatility is a key driver of
the equity term structure dynamics. A general equilibrium model jointly explains four
important patterns: (i) a potentially negative unconditional equity term premium, (ii)
countercyclical equity term premia, (iii) procyclical equity yields, and (iv) premia to
value and growth claims respectively increasing and flat with the horizon.
The economic mechanism hinges on the interaction between heteroscedastic long-run growth---
which leads to countercyclical risk premia---and homoscedastic short-term shocks under
limited market participation---which produce sizable risk premia to short-term cash
flows. The equity slope dynamics hold irrespective of the sign of its unconditional
average.
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Best paper award at the 13th International Paris Finance
Meeting 2015. |
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This paper documents that (i) the labor-share is a strong predictor of both the value and
duration premia, (ii) these premia are highly correlated, and (iii) the labor-share does not
forecast the component of the value premium orthogonal to the duration premium. A simple
equilibrium model with labor rigidity and heterogeneity in cash-flow durations rationalizes
these stylized facts. The economic channel is a term-structure effect: labor rigidity boosts
short-run dividend risk because wages are more responsive to permanent than transitory shocks.
This leads to downward-sloping equity risk and to a cross-sectional duration premium. In turn,
value firms earn a compensation over growth firms which is predicted by labor-share variation.
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| Intuition and leading equilibrium models are at odds with
the empirical evidence that expected returns are weakly related to volatility at the market level. This
paper proposes a closed-form general equilibrium model, which connects the investors' expectations of
fundamentals with those of market returns, as documented by survey data. Forecasts suggest that investors
feature pro-cyclical optimism and, then, overestimate the persistence of aggregate risk. In bad times,
the forward-looking component of stock volatility offset the transient risk and leads to a weak
risk-return relation, in line with survey data about market returns. The model mechanism is robust to
many features of financial markets.
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This paper exploits information from the variance-ratios of macroeconomic variables to infer about
the short and long-run components of dividend risk and inflation risk.
While labor rigidity shifts dividend risk towards the short horizon, it also reveals --by means of
labor-share variation-- the component of inflation risk which is correlated with fundamentals.
A simple general equilibrium model with labor rigidity can explain how inflation interacts with the
real growth and the labor-share, as well as many patterns of the term-structures of real and nominal
bond yields. The model is robust to many properties of equity returns.
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In the U.S. non-financial corporate sector, the variance ratio (VR) of profits is downward
sloping and the VR of labors costs is upward sloping. We argue that these stylized facts are
due to profits and labor responding differently to business cycle shocks, i.e. an implicit
insurance between workers and shareholders. Labor costs under-react to these shocks, defined
as innovations to the transitory component of output, while profits over-react. We show that
this mechanism is responsible for the heterogeneity in the timing of risk. While output growth
risk is flat across horizons, business-cycle insurance leads to labor cost growth variance
increasing with the horizon and to profit growth variance decreasing with the horizon. The
component of both growth rates unrelated with business cycle shocks does not lead to a
substantial horizon effect. Accordingly, labor share variation helps explaining downward sloping
profit growth risk across industries.
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| Demand Shocks, Timing Preferences and the Equilibrium Term Structures
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Leading asset pricing models fail to describe the downward-sloping term-structure of equity. This paper proposes
a closed-form framework where both supply- and demand-shocks contribute to equilibrium prices under either full or
incomplete information. The joint role of timing preferences and demand-shocks on the equilibrium term-structures
of bond and equity is characterized. The model reconciles standard asset pricing facts, such as the low and smooth
risk-free rate, the high equity premium and volatility, with positive and negative slopes respectively of bond and
equity. Under incomplete information, the minimum requirement on information quality, which preserves the slopes
of the term-structures, is derived. Information quality barely affects the unconditional moments of equity returns
but is crucial to their term-structure properties, which appear as an important diagnostics of asset pricing
frameworks. |
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Low Frequency VIX and Equilibrium Option Pricing
(co-authors: C. Meinerding, C. Schlag).
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Pandemic Tail Risk
(co-authors: M. Breugem, R. Corvino, L. Schoenleber).
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Downward-Sloping Equity Risk
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The Timing of Information Value
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| Multivariate Jump Arrivals: the Variance Gamma Case |
| in Mathematical and Statistical Methods for Actuarial Sciences and Finance, ed. by C. Perna and M. Sibillo, Springer Verlag 2011. |
| Pure Jump Models for Energy Prices |
| Energy Risk, 7(6), 2010. Presented at the II FIMA International Conference 2008. |