Mariano Massimiliano Croce

Risks for the Long-Run and the Real Exchange Rate

We propose an equilibrium model that can explain a wide range of international finance puzzles, including the high correlation of international stock markets, despite the lack of correlation of fundamentals. We conduct an empirical analysis of our model, which combines cross-country-correlated long-run risk with Epstein and Zin preferences, using U.S. and U.K. data, and show that it successfully reconciles international prices and quantities, thereby solving the international equity premium puzzle. These results provide evidence suggesting a link between common long-run growth perspectives and exchange rate movements.

Long-Run Productivity Risk: A New Hope for Production-Based Asset Pricing?

This study examines the intertemporal distribution of productivity risk. Focusing on post-war US data, I show that the conditional mean of productivity growth is time-varying and extremely persistent. This generates uncertainty about the long-run perspectives of economic growth and affects asset prices. The data suggest that stock market prices are very sensitive to long-run news about productivity growth. After establishing this empirical link, I develop a production-based asset pricing model featuring long-run uncertainty about the productivity growth rate, convex adjustment costs, and recursive preferences à la Epstein-Zin. This model reproduces key features of both asset prices and macroeconomic quantities, including consumption, investment, and output. I also provide a detailed examination of the role of the intertemporal elasticity of substitution, relative risk aversion, and adjustment costs in this type of economy.

Production-Based Term Structure of Equity Returns

We study the link between timing of cash flows and expected returns in general equilibrium production economies. Standard neoclassical RBC models produce an upward-sloping term structure of equity returns. Our economy incorporates heterogeneous exposure to aggregate productivity shocks across capital vintages, yielding a downward-sloping term structure over a ten-year horizon, consistent with the empirical findings of Binsbergen et al. (2012a, b). This result is preserved after the introduction of an endogenous stock of growth options that enables us to reproduce the empirical negative relationship between cash-flow duration and expected returns in the cross section of book-to-market sorted stocks.

Currency Risk Factors in a Recursive Multi-Country Economy

Focusing on the ten countries with the most-traded currencies, we provide novel empirical evidence about the existence of significant heterogenous exposure to global growth news shocks. We incorporate this empirical fact in a frictionless risk-sharing model with recursive preferences, multiple countries, and multiple consumption goods whose supply is subject to both global and local short- and long-run shocks. Since news shocks are priced, heterogenous exposure to global long-run growth shocks results in both a relevant reallocation of international resources and currency adjustments. Our unified framework replicates the properties of the HML-FX and HML-NFA carry trade strategies studied by Lustig et al. (2011) and Della Corte et al. (2013).

Welfare Costs in the Long Run

This study provides general methods to measure and characterize the welfare costs of long-run consumption uncertainty with Epstein and Zin (1989) preferences. I find that long-run uncertainty can create significant welfare costs even when risk aversion is moderate and the short-run consumption volatility low. These findings are relevant for the assessment of policies that require a trade-off between short- and long-run stabilization.

Recursive Allocations and Wealth Distribution with Multiple Goods: Existence, Survivorship, and Dynamics

We characterize the equilibrium of a complete markets economy with multiple agents featuring a preference for the timing of the resolution of uncertainty. Utilities are defined over an aggregate of two goods. We provide conditions under which the solution of the planners problem exists and it features a non-degenerate invariant distribution of Pareto weights. We also show that perturbation methods replicate the salient features of our recursive risk-sharing scheme, provided that higher order terms are included.

News Shocks and the Production-Based Term Structure of Equity Returns

We propose a production-based general equilibrium model to study the link between timing of cash flows and expected returns both in the cross section of stocks and along the aggregate equity term structure. Our model incorporates long-run growth news with time-varying volatility and slow learning about the exposure that firms have with respect to these shocks. Our framework provides a unified explanation of the stylized features of the slope of the term structure of equity returns, its variations over the business cycle, and the negative relationship between cash-flow duration and expected returns in the cross section of book- to-market-sorted portfolios.

International Asset Pricing with Risk-Sensitive Agents

We propose a frictionless general equilibriummodel in which two international consumers with recursive preferences trade two consumption goods and a complete set of date- and state-contingent securities. Consumption home bias and concern for the temporal distribution of risk generate rich dynamics for international prices and quantities. In our model, exchange rate movements are as volatile as they are in the data. Furthermore, both the volatility of the exchange rate movements and risk premia are endogenously time varying and history dependent.

A Tax Plan for Endogenous Innovation

In times when elevated government debt raises concerns about dimmer global growth prospects, we ask: How can the government provide incentives for innovation in a fiscally sustainable way? We address this question by examining the Ramsey problem of finding optimal tax and subsidy schemes in a model in which growth is endogenously sustained by risky innovation. We characterize the shadow value of growth and entry in the innovation sector. We find that a profit tax is required to replicate the first-best in order to balance the positive spillovers of innovative activity. At the second-best, the profit tax is designed to optimally respond to growth shocks above and beyond what is prescribed by the standard tax-smoothing incentives in economies with exogenous growth. The interplay of risk and innovation opens a new margin for optimal taxation.

Uncertainty-Induced Reallocations and Growth

Focusing on both micro and aggregate U.S. data, we show the existence of a significant link between aggregate uncertainty and reallocation of resources away from R&D-intensive capital. This link is important because a decrease in the aggregate share of R&D-oriented capital forecasts lower medium-term growth. In a multi-sector production economy in which (i) growth is endogenously supported by risky R&D investments, and (ii) the representative agent is volatility-risk averse and has access to other safer technologies that do not support growth, uncertainty shocks have a first-order negative impact on medium-term growth and welfare.