The price of risk for a shock depends on its dynamic effects on the economy. We derive the relationship between risk prices and dynamic impacts in a range of theoretical models and also estimate it empirically.
In many affine asset pricing models, the innovation to the pricing kernel is a function of innovations to current and expected future values of an economic state variable, often consumption growth, aggregate market returns, or short-term interest rates. The impulse response of the priced state variable to various shocks has a frequency (Fourier) decomposition, and we show that the price of risk for a given shock can be represented as a weighted integral over that spectral decomposition. In terms of consumption growth, Epstein–Zin preferences imply that the weight of the pricing kernel lies largely at low frequencies, while internal habit-formation models imply that the weight is shifted to high frequencies. We estimate spectral weighting functions for the equity market semi-parametrically and find that they place most of their weight at low frequencies, consistent with Epstein–Zin preferences. For Treasuries, we find that investors view increases in interest rates at low frequencies and decreases at business-cycle frequencies negatively.
Allowing for unstructured uncertainty about consumption dynamics leads to high risk premia, volatile asset prices, and substantial return predictability.
We study an agent who is unsure of consumption dynamics. She estimates her consumption process non-parametrically to place minimal restrictions on dynamics. We show that the worst-case model that she uses for pricing, given a penalty on deviations from the point estimate, is similar to a long-run risk model. This result cannot in general be matched in a fixed model with only parameter uncertainty. With a single parameter determining risk preferences, the model generates high and volatile risk premia and matches R²s from return forecasting regressions, even though risk aversion is below 5 and the worst-case dynamics are nearly indistinguishable from the true model.
I develop a new long-run variance estimator and use it to estimate the long-run variance of consumption growth. Point estimates are lower than standard long-run risks calibrations, but the more conservative calibrations cannot be ruled out. The estimates are useful more generally for calibrating models with recursive preferences.
When long-term interest rates are high relative to short-term rates, physical investment shifts towards short-term projects.
I review the history of executive compensation disclosure and other government policies affecting CEO pay. In so doing, I also review the literature on the effects of these policies. Disclosure has increased nearly uniformly since 1933. A number of other regulations, including special taxes on CEO pay and rules regarding votes on some pay packages have also been introduced, particularly in the last 20 years. However, there is little solid evidence that any of these policies have had any substantial impact on pay. We can conclude that policy changes have helped drive the move towards more use of stock options, but there is no conclusive evidence on how policy has affected the level or composition of pay otherwise. I also review evidence from overseas on "Say on Pay," recently proposed in the US, which would allow nonbinding shareholder votes on CEO compensation. The experiences of other countries have been positive, with tighter linkages between pay and performance and improved communication with investors. Mandatory say on pay would be beneficial in the US.
Only the top 10% of US earners have seen their incomes grow faster than productivity since 1966. Part of the top-earner income growth is driven by market forces (superstar economics); the only feasible pro-equality policy here is more progressive taxation. For top corporate executives, however, non-market forces (CEO-Board complicity in pay setting) are important, so other policies are warranted. Increased disclosure and improved corporate governance would distribute economic gains more evenly across society and boost firms’ value.
Europe’s jobs outlook has brightened over the past decade. Recent research suggests that about half the rise in job creation is due to labour market reforms, but much of the rest is due to changing social norms concerning female and immigrant labour force participation. But what’s good for European job creation seems to be bad for labour productivity growth – a trade-off that European policymakers must be willing to acknowledge and address.