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APE-7: Testing Asset Pricing Models
In Search of Preference Shock Risks: Evidence from Longevity Risks and Momentum Profits
Nanyang Technological University
Time-preference shocks affect agents' preferences for assets with different durations. We consider longevity risk as the sources of time-preference shocks and model it in the recursive preferences setting. This implies a consumption-based three-factor model, including longevity risk, consumption growth rate, and the market portfolio, where longevity has a negative price of risk. Empirically, both the Fama-French three-factor model augmented by longevity risk and the consumption-based model explain many well-known cross-sectional portfolios. Notably, we find that longevity risk and the momentum factor share a common business cycle component. Prior winners (losers) provide hedging against mortality (longevity) risk and thus have higher (lower) expected returns, because winners have shorter equity durations than losers. Time-varying longevity risk captures most momentum profits over time, including the large momentum crashes observed in the data.
Asset Pricing with Beliefs-Dependent Utility and Learning
1University of Geneva, Swiss Finance Institute; 2Boston University
This paper studies equilibrium in a pure exchange economy with unobservable Markov switching growth regimes and beliefs-dependent risk aversion. Risk aversion is stochastic and depends nonlinearly on consumption and beliefs. Equilibrium is obtained in closed form. The market price of risk, the interest rate and the stock return volatility acquire new components tied to fluctuations in beliefs. A three-regime specification is estimated using GMM. Model moments match their empirical counterparts for a variety of unconditional moments including the equity premium and volatility. Dynamic features of the data, such as the countercyclical behaviors of the equity premium and volatility, are also captured. Model volatility provides a good fit for realized volatility. A new factor, the Information Risk Premium, is found to be a strong predictor of future excess returns. These results are obtained with an estimated risk aversion fluctuating between 1.43 and 1.8.
Heterogeneous Taxes and Limited Risk Sharing: Evidence from Municipal Bonds
1Columbia University; 2Southern Methodist University; 3UNC Chapel Hill; 4Imperial College Business School
Heterogeneity in the taxation of asset returns can create ownership clienteles. Using a simple model, we demonstrate that an important consequence of tax-policy-induced ownership segmentation is to limit risk-sharing, creating regions of the aggregate demand curve for the asset that are downward-sloping. As a result, the constraints of the ownership clientele impact the asset price response to variations in asset supply and demand, and make the assets' price more sensitive to movements in idiosyncratic risk. We test these predictions on U.S. municipal bonds, where cross-state variation in state tax privilege policies results in different levels of home-state-biased ownership of local municipal bonds. In states with high tax-induced ownership segmentation, we find greater susceptibility of municipal bond yields to demand and supply variation, heightened sensitivity of yields to local political uncertainty, and greater difficulties in raising capital for public projects.
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Conference: EFA 2017
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