Soohun Kim

Asset Prices in Turbulent Markets with Rare Disasters

I propose a parsimonious econometric model for the stochastic process governing the evolution of per capita consumption and stock market dividend over time. The model features stochastic volatility of consumption and dividend growth rates, and time-varying likelihood of rare disasters. I embed this time-variation of risk in an endowment economy with a representative agent and estimate the parameters from U.S. stock market data using Maximum Likelihood. Allowing for time-varying likelihood of rare disasters improves the models performance. My model successfully explains a number of empirical puzzles: the high equity risk premium, excessive volatility of equity return, predictability of market returns through the price-to-dividend ratio, and the cyclical patterns observed in the term structure of the yield on dividend strips. In addition, the model-implied correlations between equity premium, variance risk premium, and the implied volatility of deep OTM put options are consistent with empirical findings in the literature.

Global Diversification with Local Stocks: A Road Less Traveled

Utilizing approximately 51,000 sample firms from developed markets over 1995-2014, we document a stark heterogeneity in global integration at the firm-level and study its implications for diversification. Specifically, the adjusted R-square, our integration measure, is widely distributed across firms, within and across sample markets. A firm’s integration is significantly affected by its style, country, and industry attributes. Systematically identifying and holding “local stocks” that are minimally driven by the common global factors, investors can significantly benefit from diversification within developed markets. Thus, the diversification gains solely inferred from the market indices much understate the potential benefits that world markets can provide.

Properties of the Pukthuanthong-Roll Stochastic Discount Factor

Pukthuanthong and Roll (2016) (PR) construct a clever candidate stochastic discount factor (SDF) that uses a vast collection of individual security returns. I show that the PR approach provides a consistent estimate of a valid SDF when the SDF is an affine function of a finite number of economy wide pervasive factors. I show how to modify the approach in PR to the case where the number of securities varies over time. The PR approach automatically selects all of the pervasive factors in an economy without the need for specifying the number of factors.

Asset Prices in an Economy Where Volatility Comes with the Intensity of Rare Disaster

This paper proposes a regime-switching asset pricing equilibrium model where volatility and the intensity of a rare disaster comove with MSM(Markov Switching Multifractal, a generalization of two-state regime-switching of Hamilton (1989) into multifrequencies) dynamics. Using monthly returns from 1927 to 2011, I estimate the joint evolution of volatility and the intensity of a rare disaster with five frequencies, generating a sizable amount of risk premium with a reasonable level of risk aversion as well as excessive volatility of market returns and predictability of long-horizon returns through price to dividend ratio. Yield curve of dividend strips reveals investors forecasts on the future path of volatility. With in inflation jump in the event of rare disaster, the model demonstrates features of nominal bond return predictability documented in Fama and Bliss (1987) and Cochrane and Piazzesi (2005). Jumps due to regime-switching and rare disaster explain the substantial size of Variance Risk Premium. Deep out-of-the-money puts are highly priced as hedging instruments for downside tail-risk, yielding a smirk on the implied volatility surface.

Modeling Dynamic Term Structure of Equity Premia with Regime Switching Economy

This paper proposes a consumption based asset pricing model in which the dynamic term structure of equity premia captures the stylized behavior of empirical counterpart. In the fi nancial crisis in late 2000s, the level of equity premium went up and especially the equity premium for a short horizon surged with a spike. To model these phenomena, I estimate two state regime switching model for the bivariate process of consumption and dividend over the period 1930-2011, and fi nd that the risk of regime switching can explain the level and slope of term structure of equity premia and the high volatility of short duration equity premium. In the economic downturn, accompanied with low growth and high volatility, the representative agent requires higher premium on equity, and since short duration assets are more exposed to the recession, those assets are heavily discounted. Consequently, the dynamics of term structure of equity premia show the following features: countercyclical level, procyclical slope, and high volatility of short term equity premium.