Amir Yaron

Cyclical Dynamics in Idiosyncratic Labor Market Risk

Is individual labor income more risky in recessions? This is a difficult question to answer because existing panel data sets are so short. To address this problem, we develop a generalized method of moments estimator that conditions on the macroeconomic history that each member of the panel has experienced. Variation in the cross‐sectional variance between households with differing macroeconomic histories allows us to incorporate business cycle information dating back to 1930, even though our data do not begin until 1968. We implement this estimator using household‐level labor earnings data from the Panel Study of Income Dynamics. We estimate that idiosyncratic risk is (i) highly persistent, with an annual autocorrelation coefficient of 0.95, and (ii) strongly countercyclical, with a conditional standard deviation that increases by 75 percent (from 0.12 to 0.21) as the macroeconomy moves from peak to trough.

What's Vol Got to Do With It

Uncertainty plays a key role in economics, finance, and decision sciences. Financial markets, in particular derivative markets, provide fertile ground for understanding how perceptions of economic uncertainty and cashflow risk manifest themselves in asset prices. We demonstrate that the variance premium, defined as the difference between the squared VIX index and expected realized variance, captures attitudes toward un- certainty. We show conditions under which the variance premium displays significant time variation and return predictability. A calibrated, generalized Long-Run Risks model generates a variance premium with time variation and return predictability that is consistent with the data, while simultaneously matching the levels and volatilities of the market return and risk free rate. Our evidence indicates an important role for transient non-Gaussian shocks to fundamentals that affect agents’ views of economic uncertainty and prices.

The Welfare Cost of Business Cycles Revisited: Finite Lives and Cyclical Variation in Idiosyncratic Risk

This paper investigates the welfare costs of business cycles in a heterogeneous agent, overlapping generations economy which is distinguished by idiosyncratic labor market risk. Aggregate variation arises both in terms of aggregate productivity shocks and countercyclical variation in the volatility of idiosyncratic shocks. Based on both aggregate data and microeconomic data from the Panel Study on Income Dynamics, we find the welfare benefits of eliminating aggregate variation to be large an order of magnitude larger than those originally documented by Lucas (1987). The key difference is countercyclical variation in idiosyncratic risk, which both amplifies the welfare cost of aggregate productivity shocks and imposes a cost of its own. The magnitude of these effects increases non-linearly in risk aversion. Our results support the increasingly popular notion that distributional effects are an important aspect of understanding the welfare cost of business cycles.

The Asset Pricing-Macro Nexus and Return-Cash Flow Predictability

In this paper we develop a measure of aggregate dividends (net payout) and a corresponding valuation ratio that incorporate the economic restrictions that all outstanding equity should be held by investors. Using this market clearing based aggregate measure of payouts changes the traditional views on the sources of asset price variation; with the aggregate dividend measure, a lot of the asset price variation is due to predictability of payout growth. In addition, the new aggregate payout measure is naturally cointegrated with aggregate consumption. We develop a long-run risks based economic model that incorporates this restriction. We show that the model can account for the return and payout growth predictability needed to explain the asset price variation in conjunction with the risk premium and volatility puzzles.

Identifying Long-Run Risks: A Bayesian Mixed-Frequency Approach

We develop a nonlinear state-space model that captures the joint dynamics of consumption, dividend growth, and asset returns. Building on Bansal and Yaron (2004), our model consists of an economy containing a common predictable component for consumption and dividend growth and multiple stochastic volatility processes. The estimation is based on annual consumption data from 1929 to 1959, monthly consumption data after 1959, and monthly asset return data throughout. We maximize the span of the sample to recover the predictable component and use high-frequency data, whenever available, to efficiently identify the volatility processes. Our Bayesian estimation provides strong evidence for a small predictable component in consumption growth (even if asset return data are omitted from the estimation). Three independent volatility processes capture different frequency dynamics; our measurement error specification implies that consumption is measured much more precisely at an annual than monthly frequency; and the estimated model is able to capture key asset-pricing facts of the data.

Equity Capital: A Puzzle?

In almost any equilibrium model, shifts in sectoral wealth have direct implications for asset returns so as to induce investors to hold more or less of their wealth in the sector. For an expanding sector, these inducements can be in the form of higher mean or lower volatility of asset. In this paper, we document that shifts in sectoral financial wealth have virtually no bearing on the subsequent mean and volatility of sectoral returns. About 90% of the wealth share fluctuations are due to movements in net payouts and 10% due to changes in expected returns. Our evidence is that sectoral wealth and asset returns show no relation|this leads to the equity capital puzzle. Why then are investors willing to hold more (less) wealth share of an expanding (contracting) sector?

Asset Prices and Intergenerational Risk Sharing { the Role of Idiosyncratic Earnings Shocks ⁄

Abstract In their seminal paper, Rajnish Mehra and Edward Prescott (1985) were the first among many subsequent authors to suggest that non-traded labor-market risk may provide a resolution to the equity premium puzzle. The most direct demonstration of this was Constantinides and Duffie (1996) , who showed that, under certain conditions, cross-sectionally uncorrelated unit root shocks that become more volatile during economic contractions can resolve the puzzle. We examine the robustness of this to life-cycle effects. Retired people, for instance, do not face labor-market risk. If we incorporate them, to what extent will the equity premium be resurrected? Our answer is “not very much.” Our model, with realistic life-cycle features, can still account for about 75 percent of the average equity premium and the Sharpe ratio observed on the U.S. stock market.

How Well Do Mexican Banks Manage Their Reserves

In this paper we investigate how well banks manage their reserves. The optimal policy takes into account expected foregone interest on excess reserves and penalty costs for going below required reserves. Using a unique panel data set on daily clearing house settlements of a cross-section of Mexican banks we estimate the deposit uncertainty banks face, and in turn their optimal reserve behavior. The most important variables in forecasting the deposit uncertainty are the interbank fund-transfers of the day, certain calendar dates, and the interest rate differential between the money market rate and the discount rate—a measure reflecting the banks opportunity cost of money holdings. For most banks, the models prediction accord relatively well with the observed reserve behavior of banks. The model produces reserve costs that are significantly smaller relative to the case when reserves are set via a simple rule of thumb. Furthermore, alternative motives for holding reserves (such as liquidity and reputation effects) do not seem to explain why certain banks hold relatively large reserves.

Fearing the Fed: How Wall Street Reads Main Street

Using intraday stock returns around macroeconomic news announcements (MNAs), we find strong evidence of persistent, cyclical variation in the stock markets response to MNA surprises. The response is particularly strong coming out of recessions and is gradually attenuated as the economy expands. We show that this cyclical pattern can be explained by a regime-switching model. In the model, we find that the direction and shape of the markets response reflect the evolution of beliefs about the state of the economy and monetary policy. The risk of an interest rate hike can entirely mitigate (and even reverse) the effect of positive MNA surprises on returns. This mechanism is consistent with the data -- positive MNA surprises coincide with negative stock market returns when there is substantial uncertainty over monetary policy.

Equilibrium Wealth Share Dynamics

We argue that the first-order movements in sectoral wealth shares are potentially driven by changes in hedging demand and not mean-variance tradeoffs, in stark contrast to widely-used models. In the quarterly sample over 1952–2015 we find that on average 60 and 73 percent of financial and real estate wealth, respectively, arises primarily from households’ motive to hedge shocks to demand. We analyze these phenomena with a two-sector model that features endogenous movements in wealth shares, returns, variances, and asset demand. We document two modeling assumptions required to match key features of the data: imperfect goods and demand shocks. ∗Fuqua School of Business, Duke University †Carlson School of Management, University of Minnesota ‡The Wharton School, University of Pennsylvania