Ravi Bansal

Consumption, Dividends, and the Cross-Section of Equity Returns

We show that aggregate consumption risks embodied in cash flows can account for the puzzling differences in risk premia across book-to-market, momentum, and size-sorted portfolios. The dynamics of aggregate consumption and cash flow growth rates, modeled as a vector autoregression, are used to measure the consumption beta of discounted cash flows. Differences in these cash flow betas account for more than 60% of the cross-sectional variation in risk premia. The market price for risk in cash flows is highly significant. We argue that cash flow risk is important for interpreting differences in risk compensation across assets. Copyright 2005 by The American Finance Association.

The Forward Premium Puzzle: Different Tales from Developed and Emerging Economies

In this paper we document new results regarding the forward premium puzzle. The often found negative correlation between the expected currency depreciation and interest rate differential is, contrary to popular belief, not a pervasive phenomenon. It is confined to developed economies, and here only to states where the U.S. interest rate exceeds foreign interest rates. Furthermore, we find that differences across economies are systematically related to per capita GNP, average inflation rates, and inflation volatility. Our empirical work suggests that it is hard to justify the cross-sectional differences in the risk premia as compensation for systematic risk. Instead, country-specific attributes seem to be important in characterizing the cross-sectional dispersion in the risk premia.

A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles

This paper develops and estimates a monetary model that offers an explanation of some puzzling features of observed returns on equities and default-free bonds. The key feature of the model is that some assets other than money play a special role in facilitating transactions, which affects the rate of return that they offer. The model is capable of producing a low risk-free rate, a high equity premium, and an average positive relationship between maturity and term premium for default-free bonds. The models implications for the joint distribution of asset returns, velocity, inflation, money growth, and consumption growth are also compared to the behavior of these variables in the U.S. economy.

Nonparametric estimation of structural models for high-frequency currency market data

Abstract Empirical modeling of high-frequency currency market data reveals substantial evidence for nonnormality, stochastic volatility, and other nonlinearities. This paper investigates whether an equilibrium monetary model can account for nonlinearities in weekly data. The model incorporates time-nonseparable preferences and a transaction cost technology. Simulated sample paths are generated using Marcets parameterized expectations procedure. The paper also develops a new method for estimation of structural economic models. The method forces the model to match (under a GMM criterion) the score function of a nonparametric estimate of the conditional density of observed data. The estimation uses weekly U.S.-German currency market data, 1975–90.

Regime-Shifts, Risk Premiums in the Term Structure, and the Business Cycle

Recent evidence indicates that using multiple forward rates sharply predicts future excess returns on U.S. Treasury Bonds, with the R2s being around 30%. The projection coefficients in these regressions exhibit a distinct pattern that relates to the maturity of the forward rate. These dimensions of the data, in conjunction with the transition dynamics of bond yields, offer a serious challenge to term structure models. In this article we show that a regime-shifting term structure model can empirically account for these challenging data features. Alternative models, such as affine specification, fail to account for these important features. We find that regimes in the model are intimately related to bond risk premia and real business cycles.

Market Efficiency, Asset Returns, and the Size of the Risk Premium in Global Equity Markets

An important economic insight is that observed equity prices must equal the present value of the cash flows associated with the equity claim. An implication of this insight is that present values of cash flows must also quantitatively justify the observed volatility and cross-correlations of asset returns. In this paper, we show that parametric economic models for present values can indeed account for the observed high ex-post return volatility and cross-correlation observed across five major equity markets. We present evidence that cash flow growth rates contain a small predictable long-run component; this feature, in conjuction with time-varying systematic risk, can justify key empirical characteristics of observed equity prices. In many cases, our model can also capture observed equity price levels. Our evidence suggests that the ex-ante risk premium on the global market portfolio has dropped considerably - we show that this fall in the risk premium is related to a decline in the conditional variance of global real cash flow growth rates.

Growth-Optimal Portfolio Restrictions On Asset Pricing Models

We show that absence of arbitrage in frictionless markets implies a lower bound on the average of the logarithm of the reciprocal of the stochastic discount factor implicit in asset pricing models. The greatest lower bound for a given asset menu is the average continuously compounded return on its growth-optimal portfolio. We use this bound to evaluate the plausibility of various parametric asset pricing models to characterize financial market puzzles such as the equity premium puzzle and the risk-free rate puzzle. We show that the insights offered by the growth-optimal bounds differ substantially from those obtained by other nonparametric bounds.

Learning and Asset-price Jumps

We develop a general equilibrium model in which income and dividends are smooth, but asset prices are subject to large moves (jumps). A prominent feature of the model is that the optimal decision of investors to learn the unobserved state triggers large asset-price jumps. We show that the learning choice is critically determined by preference parameters and the conditional volatility of income process. An important prediction of the model is that income volatility predicts future jumps, while the variation in the level of income does not. We find that indeed in the data large moves in returns are predicted by consumption volatility, but not by the changes in the consumption level. We show that the model can quantitatively capture these novel features of the data.

Computational Aspects of Nonparametric Simulation Estimation

This paper develops a nonparametric estimator for structural equilibrium models that combines numerical solution techniques for nonlinear rational expectations models with nonparametric statistical techniques for characterizing the dynamic properties of time series data. The estimator uses the the score function from a nonparametric estimate of the law of motion of the observed data to define a GMM criterion function. In effect, it forces the economic model to generate simulated data so as to match a nonparametric estimate of the conditional density of the observed data. It differs from other simulated method of moments estimators in using the nonparametric density estimate, thereby allowing the data to dictate what features of the data are important for the structural model to match. The components of the scoring function characterize important kinds of nonlinearity in the data, including properties such as nonnormality and stochastic volatility.

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.