Research
Dynamic Trading and Asset Pricing with Time-Inconsistent Agents (with Lars A. Lochstoer and Stig R. H. Lundeby)
Presented at: FIRS Conference (2024), EFA Annual Meeting (2023), BI-SHoF Asset Pricing Conference (2024), Behavioral Finance Working Group Conference (2024), Finance and Accounting Annual Research Symposium (2024)*, Oslo Macro Conference (2023), BI Norwegian Business School Seminar (2023), Bulgarian Council for Economic Research Conference (2023), BI Workshop on Uncertainty (2023), Corvinus University Seminar (2023)
Recent survey evidence suggests that personal experiences have a strong influence on the individual's attitude towards time and impatience. Embedding this feature in a general equilibrium model, we show that even a small fraction of time-inconsistent investors with time-varying degree of short-termism cause variation in discount rates over time. As a result, the consumption of time-consistent agents is negatively correlated with discount rates, and therefore they require a compensation for this extra risk. In a setting with Epstein-Zin utility and constant risk preferences this risk helps to explain a plethora of asset pricing puzzles, even when consumption and dividend growth are i.i.d. In particular, it generates a substantial time-varying risk premium, variance premium, cross-sectional predictability, upward sloping yield curve, and high trading volume. A unique prediction of our model is that the forecast error of expected consumption growth, proxied by the subjective consumption growth mean and standard deviation, can forecast the excess market return and real risk-free rate, which we show finds support in actual US survey data.
Presented at: AFA Annual Meeting (2024), Miami Herbert Business School Seminar (2024), EFA Annual Meeting (2024)*, EEA Annual Meeting (2024)*, Finance and Accounting Annual Research Symposium (2024), Financial Engineering and Banking Society Conference (2024), Bulgarian Council for Economic Research Conference (2024), Alpine Finance Summit (2024)*, NFA (2024)*, Norges Bank Seminar (2024), BI Norwegian Business School Seminar (2023), NFN Young Scholars Nordic Finance Workshop (2023), BI Workshop on Uncertainty (2023)
This paper explores a puzzle originating from the market's persistent tendency to overestimate future spot rates, as evidenced by consistently overshooting forward rates, resulting in unusually high positive long-term returns on net zero investments. We introduce the Hairy premium to quantify this puzzle. Since the 1990s, the 10-year US Hairy premium has averaged 3% p.a., ranging between 4.8% maximum and 1.1% minimum, consistently above 0, indicating asymmetric risk-reward. The Hairy premium spans over a century and it is a global phenomenon across G11 countries. About 45% is explained by a single global factor. While 14% of its variance is attributable to conventional term premiums, unlike them, it exhibits countercyclical dynamics, relating positively to recessions and inflation expectations, thus providing hedge during bad times.
A Parsimonious Explanation for Momentum Based on the Merton Model (with Alberto Manconi and Frans A. de Roon)
Presented at: Winner of Inquire Europe Research Grant, FMA European Conference (2018), Tias Business School (2018), Nova -- BPI Asset Management Conference (2017, coauthor, keynote speech), Tilburg University (2017), EFA (2020)
We propose a novel, parsimonious explanation of momentum in securities prices based on the Merton model, where equity is treated like a call option on the firm's total assets. The convexity of equity implies that, even if the total assets' returns are iid, the equity returns are not. Within this framework, we obtain simple conditions giving rise to momentum. Simulation evidence shows that the model is capable of generating momentum returns close to those documented in the literature, and that it can match empirical findings relating momentum to information uncertainty and credit risk. Empirical tests show evidence consistent with the model, in U.S. equities as well as corporate bonds. Building on our findings, it is possible to develop an enhanced momentum trading strategy that, compared to conventional momentum strategies, delivers larger returns and has lower portfolio turnover.
A Robust Numerical Method for Solving Risk-Sharing Problems with Recursive Preferences (with Pierre Collin-Dufresne, Michael Johannes, and Lars A. Lochstoer)
We provide a robust and accurate numerical solution methodology for discrete-time, complete markets, general equilibrium risk-sharing problems when agents have recursive preferences. The agents can differ both in terms of preference parameters and beliefs. The methodology can easily handle multiple aggregate shocks and state variables. To illustrate the methodology, we consider an economy where aggregate consumption dynamics follow those in Bansal and Yaron (2004) and there are two Epstein-Zin agents with different preference parameters.
Presented at: Paris December Finance Meeting EUROFIDAI -- ESSEC (scheduled, 2019), Tilburg University Finance and Econometrics (2018, 2019), University of Zurich (2019), NFA Annual Meeting -- PhD Session (2018), EFMA "Merton H. Miller" Doctoral Seminar (2018), FMA Annual Doctoral Student Consortium (2017), FMA European Doctoral Student Consortium (2017)
I examine the role of time inconsistency, modeled by hyperbolic discounting, for the dynamics of asset prices and the wealth distribution between agents. Naive time-inconsistent investors with recursive preferences overconsume and have a lower effective elasticity of intertemporal substitution (EIS) than otherwise similar investors who are time-consistent. In both survival and overlapping-generations economies with i.i.d. consumption growth, I show that the suboptimal consumption and saving decisions of the naive time-inconsistent investors endogenously generate long-run risks in the consumption dynamics of the time-consistent agents. As a result, the presence of naive shortsighted investors increases the risk-free rate, volatility, and risk premium in the economy.