Lars-Alexander Kuehn

The Aggregate Dynamics of Capital Structure and Macroeconomic Risk

We study the impact of time-varying macroeconomic conditions on optimal dynamic capital structure for a cross-section of firms. Our structural-equilibrium framework embeds a contingent-claim corporate financing model within a consumption-based asset-pricing model. We investigate the effect of macroeconomic conditions on asset valuation and optimal corporate policies, and of preferences on capital structure. While capital structure is pro-cyclical at dates when firms re-lever, it is counter-cyclical in aggregate dynamics, consistent with empirical evidence. We also find that financially constrained firms choose more pro-cyclical policies and that leverage accounts for most of the macroeconomic risk relevant for predicting defaults, but is a poor measure of how preferences impact capital structure. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Consumption Volatility Risk

Empirically, the conditional volatility of aggregate consumption growth varies over time. While many papers test the consumption CAPM based on realized consumption growth, little is known about how the time-variation of consumption growth volatility affects asset prices. We show that in a model where (i) the agent has recursive preferences, (ii) the conditional first and second moments of consumption growth follow a Markov chain and (iii) the state of the economy is latent, the perception about conditional moments of consumption growth affect excess returns. In the data, we find that the perceived consumption volatility is a priced source of risk and exposure to it strongly negatively predicts future returns in the cross-section. These results suggest that the representative agent has an elasticity of intertemporal substitution greater than unity. In the time-series, changes in beliefs about the volatility state strongly forecast aggregate quarterly excess returns. JEL Classification: G12, G17, E44.

A Labor Capital Asset Pricing Model

We show that labor search frictions are an important determinant of the cross-section of equity returns. In the data, sorting firms by loadings on labor market tightness, the key statistic of search models, generates a spread in future returns of 6% annually. We propose a partial equilibrium labor market model in which heterogeneous firms make optimal employment decisions under labor search frictions. In the model, loadings on labor market tightness proxy for priced time variation in the efficiency of the matching technology. Firms with low loadings are not hedged against adverse matching efficiency shocks and require higher expected stock returns.

Endogenous Disasters and Asset Prices

Frictions in the labor market are important for understanding the equity premium in the financial market. We embed the Diamond-Mortensen-Pissarides search framework into a dynamic stochastic general equilibrium model with recursive preferences. The model produces realistic equity premium and stock market volatility, as well as a low and stable interest rate. The equity premium is countercyclical, and forecastable with labor market tightness, a pattern we confirm in the data. Intriguingly, three key ingredients (small profits, large job flows, and matching frictions) in the model combine to give rise endogenously to rare disasters a la Rietz (1988) and Barro (2006).

Disentangling Investment Returns and Stock Returns: The Importance of Time-to-Build

I provide new evidence on the failure of the Q-theory. The Q-theory implies the state-by-state equivalence of stock and investment returns|a important implication of many asset pricing models. Using aggregate US data, I nd there exists a realistic parameterization of the aggregate production and adjustment cost function such that empirical investment returns have rst and second moments similar to historical US stock returns. Investment and stock returns are negatively correlated, however, contradicting the Q-theory. This paper also proposes a rational explanation for this nding. A general equilibrium model with production, in which investment projects involve time-to-build, can rationalize these ndings. The model is also able to explain the negative correlation of investment growth and stock returns at the aggregate level|an observation that has been interpreted as evidence for irrational markets since it cannot be reconciled with the Q-theory of investment.

A Labor Capital Asset Pricing Model: A Labor Capital Asset Pricing Model

We show that labor search frictions are an important determinant of the cross-section of equity returns. Empirically, we find that firms with low loadings on labor market tightness outperform firms with high loadings by 6% annually. We propose a partial equilibrium labor market model in which heterogeneous firms make dynamic employment decisions under labor search frictions. In the model, loadings on labor market tightness proxy for priced time-variation in the efficiency of the aggregate matching technology. Firms with low loadings are more exposed to adverse matching efficiency shocks and require higher expected stock returns.