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Creator: Alvarez, Fernando, 1964- and Atkeson, Andrew Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 577 Abstract:
We develop a new general equilibrium model of asset pricing and asset trading volume in which agents’ motivations to trade arise due to uninsurable idiosyncratic shocks to agents’ risk tolerance. In response to these shocks, agents trade to rebalance their portfolios between risky and riskless assets. We study a positive question — When does trade volume become a pricing factor? — and a normative question — What is the impact of Tobin taxes on asset trading on welfare? In our model, economies in which marketwide risk tolerance is negatively correlated with trade volume have a higher risk premium for aggregate risk. Likewise, for a given economy, we ﬁnd that assets whose cash ﬂows are concentrated on states with high trading volume have higher prices and lower risk premia. We then show that Tobin taxes on asset trade have a ﬁrst-order negative impact on ex-ante welfare, i.e., a small subsidy to trade leads to an improvement in ex-ante welfare. Finally, we develop an alternative version of our model in which asset trade arises from uninsurable idiosyncratic shocks to agents’ hedging needs rather than shocks to their risk tolerance. We show that our positive results regarding the relationship between trade volume and asset prices carry through. In contrast, the normative implications of this speciﬁcation of our model for Tobin taxes or subsidies depend on the speciﬁcation of agents’ preferences and non-traded endowments.
Palabra clave: Liquidity, Tobin taxes, Asset pricing, and Trade volume Tema: G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Aiyagari, S. Rao Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 518 Abstract:
This paper is about a useful way of taking account of frictions in asset pricing and macroeconomics. I start by noting that complete frictionless markets models have a number of empirical deficiencies. Then I suggest an alternative class of models with incomplete markets and heterogenous agents which can also accommodate a variety of other frictions. These models are quantitatively attractive and computationally feasible and have the potential to overcome many or all of the empirical deficiencies of complete frictionless markets models. The incomplete markets model can also differ significantly from the complete frictionless markets model on some important policy questions.
Palabra clave: Macroeconomics, Incomplete markets, Frictionless market model, Asset pricing, and Friction Tema: G12 - Asset Pricing; Trading Volume; Bond Interest Rates and E13 - General Aggregative Models: Neoclassical
Creator: Koijen, Ralph S. J. and Yogo, Motohiro Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 510 Abstract:
We develop an asset pricing model with flexible heterogeneity in asset demand across investors, designed to match institutional and household holdings. A portfolio choice model implies characteristics-based demand when returns have a factor structure and expected returns and factor loadings depend on the assets' own characteristics. We propose an instrumental variables estimator for the characteristics-based demand system to address the endogeneity of demand and asset prices. Using U.S. stock market data, we illustrate how the model could be used to understand the role of institutions in asset market movements, volatility, and predictability.
Palabra clave: Demand system, Liquidity, Portfolio choice, Asset pricing model, and Institutional investors Tema: G23 - Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Hur, Sewon, Kondo, Illenin O., and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 574 Abstract:
This paper argues that the comovement between inflation and economic activity is an important determinant of real interest rates over time and across countries. First, we show that for advanced economies, periods with more procyclical inflation are associated with lower real rates, but only when there is no risk of default on government debt. Second, we present a model of nominal sovereign debt with domestic risk-averse lenders. With procyclical inflation, nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. In the absence of default risk, procyclical inflation yields lower real rates. However, procyclicality implies that the government needs to make larger (real) payments when the economy deteriorates, which could increase default risk and trigger an increase in real rates. The patterns of real rates predicted by the model are quantitatively consistent with those documented in the data.
Palabra clave: Nominal bonds, Inflation risk, Government debt, and Sovereign default Tema: F34 - International Lending and Debt Problems, E31 - Price Level; Inflation; Deflation, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, and H63 - National Debt; Debt Management; Sovereign Debt
Creator: Alvarez, Fernando, 1964- and Jermann, Urban J. Series: Endogenous incompleteness Abstract:
We study the asset pricing implications of a multi-agent endowment economy where agents can default on debt. We build on the environment studied by Kocherlakota (1995) and Kehoe and Levine (1993). We present an equilibrium concept for an economy with complete markets and with endogenous solvency constraints. These solvency constraints prevent default, but at the cost of reduced risk sharing. We show that versions of the classical welfare theorems hold for this equilibrium definition. We characterize the pricing kernel, and compare it to the one for economies without participation constraints: interest rates are lower and risk premia depend on the covariance of the idiosyncratic and aggregate shocks.
Palabra clave: Equilibrium, Default, Solvency constraints, Risk, Shocks, and Assets Tema: G12 - General financial markets - Asset pricing ; Trading volume ; Bond interest rates and D50 - General equilibrium and disequilibrium - General
Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 627 Abstract:
Time-varying risk is the primary force driving nominal interest rate differentials on currency-denominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. We show that a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation—can produce key features of actual interest rates and exchange rates. The endogenous segmentation arises from a fixed cost for agents to exchange money for assets. As inflation varies, the benefit of asset market participation varies, and that changes the fraction of agents participating. These effects lead the risk premium to vary systematically with the level of inflation. Our model produces variation in the risk premium even though the fundamental shocks have constant conditional variances.
Palabra clave: Time-varying conditional variances, Pricing kernel, Fama puzzle, Segmented markets, Forward premium anomaly, and Asset pricing-puzzle Tema: F31 - Foreign Exchange, F41 - Open Economy Macroeconomics, G15 - International Financial Markets, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, F30 - International Finance: General, and E43 - Interest Rates: Determination, Term Structure, and Effects
Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 371 Abstract:
Under mild assumptions, the data indicate that fluctuations in nominal interest rate differentials across currencies are primarily fluctuations in time-varying risk. This finding is an immediate implication of the fact that exchange rates are roughly random walks. If most fluctuations in interest differentials are thought to be driven by monetary policy, then the data call for a theory which explains how changes in monetary policy change risk. Here we propose such a theory based on a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation.
Palabra clave: Time-Varying Conditional Variances, Forward Premium Anomaly, Pricing Kernel, Segmented Markets, Asset Pricing-Puzzle, and Fama Puzzle Tema: F41 - Open Economy Macroeconomics, F30 - International Finance: General, G15 - International Financial Markets, E43 - Interest Rates: Determination, Term Structure, and Effects, F31 - Foreign Exchange, and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Lagos, Ricardo and Rocheteau, Guillaume Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 375 Abstract:
We investigate how trading frictions in asset markets affect portfolio choices, asset prices and efficiency. We generalize the search-theoretic model of financial intermediation of Duffie, Gârleanu and Pedersen (2005) to allow for more general preferences and idiosyncratic shock structure, unrestricted portfolio choices, aggregate uncertainty and entry of dealers. With a fixed measure of dealers, we show that a steady-state equilibrium exists and is unique, and provide a condition on preferences under which a reduction in trading frictions leads to an increase in the price of the asset. We also analyze the effects of trading frictions on bid-ask spreads, trade volume and the volatility of asset prices, and find that the asset allocation is constrained-inefficient unless investors have all the bargaining power in bilateral negotiations with dealers. We show that the dealers’ entry decision introduces a feedback that can give rise to multiple equilibria, and that free-entry equilibria are generically inefficient.
Palabra clave: Execution delay, Liquidity, Search, Asset prices, Trade volume, and Bid-ask spread Tema: G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages, G11 - Portfolio Choice; Investment Decisions, and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Bryant, John B. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 121 Palabra clave: Interest, Nontransferable bonds, and Money Tema: H62 - National Deficit; Surplus and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 610 Abstract:
U.S. stock prices have increased much faster than gross domestic product GDP) in the postwar period. Between 1962 and 2000, corporate equity value relative to GDP nearly doubled. In this paper, we determine what standard growth theory says the equity value should be in 1962 and 2000, the two years for which our steady-state assumption is a reasonable one. We find that the actual valuations were close to the theoretical predictions in both years. The reason for the large run-up in equity value relative to GDP is that the average tax rate on dividends fell dramatically between 1962 and 2000. We also find that, given legal constraints that effectively prohibited the holding of stocks as reserves for pension plans, there is no equity premium puzzle in the postwar period. The average returns on debt and equity are as theory predicts.
Tema: E13 - General Aggregative Models: Neoclassical, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, and H30 - Fiscal Policies and Behavior of Economic Agents: General