Assistant Professor of Finance
Research Interests: Macro-Based Asset Pricing, Bayesian Econometrics
"Term structure of risk in macrofinance models", November 2016
Abstract: I propose a model-based approach to characterize the term structure of risk in asset prices. Empirical models with alternative realistic sources of risk premium, such as the long-run risk, consumption variance shocks, and time-varying consumption disasters, serve as inputs to shock elasticities. Shock elasticities reveal how the macroeconomic shocks propagate in asset prices across alternative investment horizons. I illustrate my methodology by examining the term structure of equity risk. I find that the long-run risk model of Bansal and Yaron (2004) and a consumption disaster model of Wachter (2013) fall short to account for both the shape and the level of the term structure of risk in equity returns at the same time. A two-volatility model in spirit of Drechsler and Yaron (2011) implies a downward sloping term structure of equity risk as in the data.
Abstract: I relate the downward sloping term structure of currency carry returns to compensations for currency exposures to macroeconomic risk embedded in the joint dynamics of US consumption, inflation, nominal interest rate, and their stochastic variance. The interest rate and inflation shocks play a prominent role. Higher yield currencies exhibit higher multi-period exposures to these shocks. The prices of these risk exposures are positive and sizeable across all investment horizons. The interest rate shock operates qualitatively similar to the long-run risk of Bansal and Yaron (2004).
"Crash Risk in Currency Returns" (with M. Chernov and J. Graveline), forthcoming, Journal of Financial and Quantitative Analysis
Abstract: We quantify crash risk in currency returns. To accomplish this task, we develop and estimate an empirical model of exchange rate dynamics using daily data for four currencies relative to the US dollar: the Australian dollar, the British pound, the Swiss franc, and the Japanese yen. The model includes (i) normal shocks with stochastic variance, (ii) jumps up and down in the exchange rate, and (iii) jumps in the variance. We identify these components using data on exchange rates and at-the-money implied variances. We find that crash risk is time-varying. The probability of an upward (downward) jump in the exchange rate, associated with depreciation (appreciation) of the US dollar, is increasing in the domestic (foreign) interest rate. The probability of a jump in variance is increasing in the variance but is not related to interest rates. Many of the jumps in exchange rates are associated with macroeconomic and political news, but jumps in variance are not. On average, jumps account for 25% of total currency risk (and can be as high as 40%), as measured by the entropy of exchange rate changes, over horizons of one to three months. The dollar carry index, which is based on 21 exchange rates, retains these features. A simple calibration analysis using option-implied smiles suggests that jump risk is priced.
Last modified: March, 2017