SSRN Author: Jessica A. WachterJessica A. Wachter SSRN Content
http://www.ssrn.com/author=159310
http://www.ssrn.com/rss/en-usThu, 10 Aug 2017 06:31:10 GMTeditor@ssrn.com (Editor)Thu, 10 Aug 2017 06:31:10 GMTwebmaster@ssrn.com (WebMaster)SSRN RSS Generator 1.0REVISION: Cyclical Dispersion in Expected DefaultsA growing literature shows that credit indicators forecast aggregate real outcomes. While the literature has proposed various explanations, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless, model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks. This leads to endogenous dispersion in credit quality that varies over time and predicts future excess returns and real outcomes.
http://www.ssrn.com/abstract=2949447
http://www.ssrn.com/1615796.htmlWed, 09 Aug 2017 06:10:52 GMTREVISION: Pricing Long-Lived Securities in Dynamic Endowment EconomiesWe solve for asset prices in a general affine representative-agent economy with isoelastic recursive utility and rare events. Our novel solution method is exact in two special cases: no preference for early resolution of uncertainty and elasticity of intertemporal substitution equal to one. Our results clarify model properties governed by the elasticity of intertemporal substitution, by risk aversion, and by the preference for early resolution of uncertainty. Our results also highlight that a covariance-based factor structure arises as a very special case, rather than as a general property, of equilibrium models.
http://www.ssrn.com/abstract=2955337
http://www.ssrn.com/1615600.htmlTue, 08 Aug 2017 10:45:08 GMTREVISION: Option Prices in a Model with Stochastic Disaster RiskContrary to well-known asset pricing models, volatilities implied by equity index options exceed realized stock market volatility and exhibit a pattern known as the volatility skew. We explain both facts using a model that can also account for the mean and volatility of equity returns. Our model assumes a small risk of economic disaster that is calibrated based on international data on large consumption declines. We allow the disaster probability to be stochastic, which turns out to be crucial to the model's ability both to match equity volatility and to reconcile option prices with macroeconomic data on disasters.
http://www.ssrn.com/abstract=2555700
http://www.ssrn.com/1614104.htmlThu, 03 Aug 2017 01:14:44 GMTREVISION: Cyclical Dispersion in Expected DefaultsA growing literature shows that credit indicators forecast aggregate real outcomes. While the literature has proposed various explanations, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless, model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks. This leads to endogenous dispersion in credit quality that varies over time and predicts future excess returns and real outcomes.
http://www.ssrn.com/abstract=2949447
http://www.ssrn.com/1607867.htmlFri, 14 Jul 2017 12:15:17 GMTREVISION: Cyclical Dispersion in Expected DefaultsA growing literature shows that credit indicators forecast aggregate real outcomes. While the literature has proposed various explanations, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless, model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks. This leads to endogenous dispersion in credit quality that varies over time and predicts future excess returns and real outcomes.
http://www.ssrn.com/abstract=2949447
http://www.ssrn.com/1606340.htmlSat, 08 Jul 2017 14:50:50 GMTREVISION: Cyclical Dispersion in Expected DefaultsA growing literature shows that credit indicators forecast aggregate real outcomes. While various explanations have been offered, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless, model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks to productivity and asset values. This leads to endogenous dispersion in credit quality across firms that varies over time and predicts future excess returns and real outcomes. Our model also matches additional features of the cross-section and time-series of prices and returns.
http://www.ssrn.com/abstract=2949447
http://www.ssrn.com/1604805.htmlSat, 01 Jul 2017 19:02:04 GMTREVISION: Pricing Long-Lived Securities in Dynamic Endowment EconomiesWe solve for asset prices in a general affine representative-agent economy with isoelastic recursive utility and rare events. Our novel solution method is exact in two special cases: no preference for early resolution of uncertainty and elasticity of intertemporal substitution equal to one. Our results clarify model properties governed by the elasticity of intertemporal substitution, by risk aversion, and by the preference for early resolution of uncertainty. Our results also highlight that a covariance-based factor structure arises as a very special case, rather than as a general property, of equilibrium models.
http://www.ssrn.com/abstract=2955337
http://www.ssrn.com/1604223.htmlThu, 29 Jun 2017 14:32:42 GMTREVISION: Cyclical Dispersion in Expected DefaultsA growing literature shows that credit indicators forecast aggregate real outcomes. While various explanations have been offered, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless, model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks to productivity and asset values. This leads to endogenous dispersion in credit quality across firms that varies over time and predicts future excess returns and real outcomes. Our model also matches additional features of the cross-section and time-series of prices and returns.
http://www.ssrn.com/abstract=2949447
http://www.ssrn.com/1603473.htmlTue, 27 Jun 2017 11:16:46 GMTREVISION: Risk, Unemployment, and the Stock Market: A Rare-Event-Based Explanation of Labor Market VolatilityWhat is the driving force behind the cyclical behavior of unemployment and vacancies? What is the relation between job-creation incentives of firms and stock market valuations? We answer these questions in a model with time-varying risk, modeled as a small and variable probability of an economic disaster. A high probability implies greater risk and lower future growth, lowering the incentives of firms to invest in hiring. During periods of high risk, stock market valuations are low and unemployment rises. The model thus explains volatility in equity and labor markets, and the relation between the two.
http://www.ssrn.com/abstract=2541916
http://www.ssrn.com/1599778.htmlTue, 13 Jun 2017 12:30:20 GMTREVISION: Risk, Unemployment, and the Stock Market: A Rare-Event-Based Explanation of Labor Market VolatilityWhat is the driving force behind the cyclical behavior of unemployment and vacancies? What is the relation between job-creation incentives of firms and stock market valuations? We answer these questions in a model with time-varying risk, modeled as a small and variable probability of an economic disaster. A high probability implies greater risk and lower future growth, lowering the incentives of firms to invest in hiring. During periods of high risk, stock market valuations are low and unemployment rises. The model thus explains volatility in equity and labor markets, and the relation between the two.
http://www.ssrn.com/abstract=2541916
http://www.ssrn.com/1588061.htmlWed, 03 May 2017 18:32:38 GMTREVISION: Cyclical Dispersion in Expected DefaultsA growing empirical literature shows that proxies for credit market conditions forecast aggregate real outcomes. While researchers have proposed various explanations, the economic mechanism behind these results remains an open question. In this paper, we propose a simple mechanism and document that the same forecasting regressions results hold in our model as in the data. We base our mechanism on differential exposures of firms' productivity and capital stocks to economy-wide risks. We show how these assumptions endogenously lead to a cross section in which firms sort on measures of credit quality, that this cross-sectional dispersion of credit quality varies over time, and that dispersion forecasts both excess bond returns and real outcomes as in the data. We also confirm other predictions of the model for the cross section and time series of prices and returns.
http://www.ssrn.com/abstract=2949447
http://www.ssrn.com/1581477.htmlMon, 10 Apr 2017 07:54:36 GMTREVISION: Do Rare Events Explain CDX Tranche Spreads?We investigate whether a model with a time-varying probability of economic disaster can explain the pricing of collateralized debt obligations, both prior to and during the 2008-2009 financial crisis. Namely, we examine the pricing of tranches on the CDX, an index of credit default swaps on large investment-grade firms. CDX senior tranches are essentially deep out-of-the money put options because they do not incur losses until a large fraction of previously stable firms default. As such, these products clearly reflect the market’s assessment of rare-event risk. We find that the model can simultaneously explain prices on CDX senior tranches and on equity index options at parameter values that are consistent with the equity premium and with aggregate stock market volatility. Our results demonstrate the importance of beliefs about rare disasters for asset prices, even during periods of relative economic stability.
http://www.ssrn.com/abstract=2839966
http://www.ssrn.com/1577204.htmlSat, 25 Mar 2017 13:02:09 GMTREVISION: Option Prices in a Model with Stochastic Disaster RiskContrary to well-known asset pricing models, volatilities implied by equity index options exceed realized stock market volatility and exhibit a pattern known as the volatility skew. We explain both facts using a model that can also account for the mean and volatility of equity returns. Our model assumes a small risk of economic disaster that is calibrated based on international data on large consumption declines. We allow the disaster probability to be stochastic, which turns out to be crucial to the model's ability both to match equity volatility and to reconcile option prices with macroeconomic data on disasters.
http://www.ssrn.com/abstract=2555700
http://www.ssrn.com/1540870.htmlThu, 03 Nov 2016 05:40:55 GMTREVISION: Maximum Likelihood Estimation of the Equity PremiumThe equity premium, namely the expected return on the aggregate stock market less the government bill rate, is of central importance to the portfolio allocation of individuals, to the investment decisions of firms, and to model calibration and testing. This quantity is usually estimated from the sample average excess return. We propose an alternative estimator, based on maximum likelihood, that takes into account information contained in dividends and prices. Applied to the postwar sample, our method leads to an economically significant reduction from 6.4% to 5.1%. Simulation results show that our method produces more reliable estimates under a wide range of specifications.
http://www.ssrn.com/abstract=2443529
http://www.ssrn.com/1532878.htmlTue, 04 Oct 2016 07:30:05 GMTREVISION: Option Prices in a Model with Stochastic Disaster RiskContrary to well-known asset pricing models, volatilities implied by equity index options exceed realized stock market volatility and exhibit a pattern known as the volatility skew. We explain both facts using a model that can also account for the mean and volatility of equity returns. Our model assumes a small risk of economic disaster that is calibrated based on international data on large consumption declines. We allow the disaster probability to be stochastic, which turns out to be crucial to the model's ability both to match equity volatility and to reconcile option prices with macroeconomic data on disasters.
http://www.ssrn.com/abstract=2555700
http://www.ssrn.com/1532446.htmlSun, 02 Oct 2016 06:35:23 GMTREVISION: Risk, Unemployment, and the Stock Market: A Rare-Event-Based Explanation of Labor Market VolatilityWhat is the driving force behind the cyclical behavior of unemployment and vacancies? What is the relation between job-creation incentives of firms and stock market valuations? We answer these questions in a model with time-varying risk, modeled as a small and variable probability of an economic disaster. A high probability implies greater risk and lower future growth, lowering the incentives of firms to invest in hiring. During periods of high risk, stock market valuations are low and unemployment rises. The model thus explains volatility in equity and labor markets, and the relation between the two.
http://www.ssrn.com/abstract=2541916
http://www.ssrn.com/1530123.htmlThu, 22 Sep 2016 16:13:14 GMTREVISION: Do Rare Events Explain CDX Tranche Spreads?We investigate whether a model with a time-varying probability of economic disaster can explain the pricing of collateralized debt obligations, both prior to and during the 2008-2009 financial crisis. Namely, we examine the pricing of tranches on the CDX, an index of credit default swaps on large investment-grade firms. CDX senior tranches are essentially deep out-of-the money put options because they do not incur losses until a large fraction of previously stable firms default. As such, these products clearly reflect the market’s assessment of rare-event risk. We find that the model can simultaneously explain prices on CDX senior tranches and on equity index options at parameter values that are consistent with the equity premium and with aggregate stock market volatility. Our results demonstrate the importance of beliefs about rare disasters for asset prices, even during periods of relative economic stability.
http://www.ssrn.com/abstract=2839966
http://www.ssrn.com/1529071.htmlMon, 19 Sep 2016 06:03:37 GMT