I show that time-varying risk aversion can generate a term structure of equity risk premia that is upward sloping in bad times and downward sloping in good times. I derive three conditions that jointly generate this result. First, risk aversion is negatively correlated with consumption growth. Second, risk aversion is mean reverting and, third, preferences can become risk seeking in good states. Moreover, I propose a highly parsimonious model with one single state variable and a representative agent with utility over both consumption and wealth fluctuations that allows for states of risk-seeking preferences in equilibrium and, hence, can match the recent empirical findings on the equity term structure. In my model, the unconditional term structure of equity risk premia can be increasing, flat, or decreasing depending on the relative frequency of good and bad times. I show that time-varying risk aversion provides the first simultaneous explanation for the cyclicality of the equity term premia, the positive equity term risks, and, the predictability of stock returns without needing to assume predictability in cashflows. More broadly, my results show the relevance of time-varying risk aversion for explaining maturity-dependent risk premia.
We study the effects of limited attention on belief formation in a dynamic environment. We propose a simple theoretical model of inattentive learning and derive closed-form expressions for the limiting distortion of the true underlying distribution. When attention is drawn towards extreme observations, the limiting probability distortion takes the form of an S-shape. These belief distortions yield behavior that is similar to that implied by the preference-based distortions of prospect theory. We thus find that part of the empirical success of prospect theory might be due to abstracting away the impact of limited attention on learning. We show that our model of inattentive learning explains several aspects of investors' behavior, for instance, a preference for skewed assets; overextrapolation of past returns; stock market momentum; and the simultaneous demand for lotteries and insurance. When attention has cognitive costs, limited attention thus provides a rational unification of several biases in investor behavior.
I document a new empirical regularity in initial public offerings (IPOs): trading volume in the 600 business days following an IPO follows a U-shaped pattern. While the initial surge in turnover is well-established, I also show that trading activity subsequently rises again, with average volume increasing by approximately 22\% per annum relative to the post-listing trough. This phenomenon has not previously been reported. The increase is robust to aggregate market turnover trends and to firm size at issuance. I further demonstrate that the U-shape is linked to lockup agreements, yet not driven by insider sales or free float.
Beliefs and preferences during the life cycle (with Jorgo Goossens).
Risk and time preferences in ESG domains (with Jorgo Goossens and Marike Knoef).
Reproducibility in Management Science
Co-authors: Miloš Fišar, Ben Greiner, Christoph Huber, Elena Katok, Ali I. Ozkes, and the MSRC*.
Management Science, 70(3), 2024, p.1343-1356.