Abstract: This paper develops a theory of how TFP news shocks can impact the economy via a Keynesian supply channel. With frictional labour markets, bad TFP news reduces firms' incentive to post vacancies, worsening households' employment prospects. Households respond by accumulating liquid assets and cutting spending for precautionary reasons, triggering a recession that compounds the labour market downturn. This mechanism is outlined analytically and numerically in a heterogeneous agent New Keynesian model, with supporting local projection evidence. The combination of labour market frictions and precautionary saving is necessary to match the joint output and nominal interest rate dynamics observed empirically following a news shock. In contrast to previous theories, the transmission mechanism leaves room for policy to mitigate the shock's contractionary effects.

With Utso Pal Mustafi

Abstract:  How safe or risky is government debt? According to asset pricing theory, this depends on the covariance between the real holding period return on the public portfolio and the prevailing stochastic discount factor (SDF). Through the lens of a simple monetary-fiscal model with bond investors who price risk, we show that the sign of this covariance is a sufficient statistic for the underlying policy regime. We recover the SDF from the cross-section of returns, using a novel method which allows us to remain broadly agnostic about the underlying asset pricing model, and use this to evaluate the key covariance of interest using US and UK data from 1926-2024. We find that US government debt was i) risky in the pre-WWII period but became safe after the Treasury-Fed accord of 1951, ii) risky from 1965-1985, iii) safe from 1985-2020, and iv) seems to have become risky in the post-pandemic 2020-2024 period. We estimate that in 2024 the risk premium component was currently adding 100bps (annualised) to the average funding cost which appears in the US government budget constraint. 

Abstract:  Jobs become more precarious in recessions, while risk premia tend to rise. This paper links these two empirical regularities in a consumption-based asset pricing model with imperfectly insurable job loss risk, and shows that this offers a unified explanation for several macro-finance phenomena, including the equity premium, risk-free rate and return predictability puzzles. Since job loss leads to a large decline in idiosyncratic consumption, agents become less willing to bear risk when jobs become more insecure. Consequently, extrinsic risk aversion increases endogenously when job insecurity rises, generating high, countercyclical risk premia. Consistent with this mechanism, the job loss rate is shown to be a robust forecaster of future excess returns.  The model's equity premium Euler equation can be estimated directly, producing a value of 12 for the risk aversion parameter versus estimates for the standard CCAPM which exceed 100. The precautionary saving motive spurred by job loss risk means that the risk-free rate puzzle is avoided, while the model explains the cross-section of returns more effectively than several other consumption-based models. 

Abstract:  I develop a macro-finance model which can simultaneously resolve the equity premium puzzle and the unemployment volatility puzzle in a general equilibirum setting. The key friction is the presence of uninsurable job loss risk which households must reckon with when making consumption and asset allocation decisions. When jobs become more precarious, this increases risk premia since households endogenously become more risk averse due to the greater degree of background risk now present. When firms use the prevailing pricing kernel to make intertemporal decisions, I show that this leads to a negative feedback loop; since hiring a worker is a risky investment, the rise in risk premia causes a further drop in vacancy posting, which pushes up risk premia further via the unemployment risk channel. For a risk aversion of 5.5 and a realistic TFP process, the model can match the equity premium, the risk-free rate, and the volatility of unemployment, as well as a number of other asset pricing moments. When agents are risk-neutral, as in the standard Diamond-Mortensen-Pissarides model, the volatility of unemployment is four times lower. 

With Paul Beaudry and Franck Portier 

Abstract: The way monetary policy is conducted is a key element in New Keynesian models, and crucially determines allocations properties. We show that assuming monetary authorities follow a Taylor rule may bias estimation of New Keynesian type models for two reasons. The first one is theoretically trivial, and is a standard misspecification bias that occurs if the actual conduct of policy does not follow the model specified Taylor rule. The second one is more subtle, and we refer to it as a determinacy bias. It occurs when wrongly assuming a Taylor rule restricts the set of admissible model deep parameters when one requires the equilibrium to be determinate, as is almost always the case in the applied literature. Using US data, we show that the determinacy bias is a serious problem in small scale New Keynesian models, as the slope of Phillips curve is biased upwards. The misspecification bias is a serious problem when estimating a medium-scale model, as it affects the contribution of the various shocks to macroeconomic fluctuations. We propose an alternative agnostic specification of the policy rule that is immune to both misspecification and determinacy biases.

With Utso Pal Mustafi

Abstract: We develop a heterogeneous-agent New Keynesian model with endogenous non-Gaussian labour income risk to address the equity premium and risk-free rate puzzles. Frictional labour markets generate unemployment risk that causes uninsurable consumption declines. Adverse aggregate shocks reduce dividends and raise unemployment risk, making equities risky. The estimated model matches the equity premium with a risk aversion coefficient of 4.5, while a precautionary saving motive keeps the risk-free rate low. It also replicates evidence that monetary policy affects discount rates rather than cash flows, and we find that a hawkish Taylor rule raises the equity premium.

Hedge funds increasingly intermediate relative-value imbalances in sovereign bond markets using short-term repo financing. I develop and estimate an equilibrium model in which secured funding conditions, arbitrage returns, and leveraged positions are jointly determined. Dealer balance-sheet and liquidity costs make repo supply upward sloping, while funding risk limits hedge funds’ willingness to expand leveraged positions. Using transaction-level data from the UK gilt repo market, I identify repo-supply and arbitrage-demand shocks and estimate the elasticities of dealer funding, hedge-fund borrowing, and outside arbitrage capital. I find that all three are inelastic. Consequently, hedge funds absorb a large share of cash-derivative imbalances, and their withdrawal requires a substantial widening of arbitrage spreads. The model generates `fragile tranquillity' --- benign funding conditions compress arbitrage returns while supporting larger leveraged positions. A central bank repo facility strengthens this mechanism by stabilising repo rates and reducing funding risk, meaning that funding backstops can therefore improve rate control while simultaneously increasing positions exposed to risks outside the backstop.

With Nikolas Kuhlen

Abstract:  We develop a quantitative measure of one economically relevant dimension of news coverage: the degree of news concentration. Intuitively, news coverage is likely to become highly concentrated around particularly newsworthy events, meaning it potentially conveys information about the economy's latent state variables. We observe that news concentration does indeed exhibit clear spikes around important economic, financial, and political events, and find that these increases are associated with two key features: an immediate rise in uncertainty, consistent with theory, and a future macroeconomic contraction. These increases are not found to be driven by a range of typical macroeconomic shocks. The variable is a robust forecaster of recessions and is priced in the cross-section of returns. We rationalise the latter result through an ICAPM framework by showing that innovations in news concentration represent volatility news.