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Session Overview
APE-2: Time-varying liquidity and risk premia
Thursday, 22/Aug/2019:
8:30 - 10:00

Session Chair: Rossen Valkanov, UCSD
Location: D -104

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The TIPS Liquidity Premium

Martin M. Andreasen1, Jens Christensen2, Simon Ridell3

1Aarhus University, Denmark; 2Federal Reserve Bank of San Francisco; 3Amazon

Discussant: Anders Trolle (HEC Paris)

We introduce an arbitrage-free term structure model of nominal and real yields that accounts for liquidity risk in Treasury inflation-protected securities (TIPS). The novel feature of our model is to identify liquidity risk from individual TIPS prices by accounting for the tendency that TIPS, like most fixed-income securities, go into buy-and-hold investors’ portfolios as time passes. We find a sizable and countercyclical TIPS liquidity premium, which greatly helps our model in matching TIPS prices. Accounting for liquidity risk also improves the model’s ability to forecast inflation and match surveys of inflation expectations, although none of these series are included in the estimation.

efa2019-APE-2-839-The TIPS Liquidity Premium.pdf

The Time Variation in Risk Appetite and Uncertainty

Geert Bekaert1, Eric Engstrom2, Nancy R. Xu3

1Columbia Business School, United States of America; 2Federal Reserve Board, United States of America; 3Boston College, Carroll School of Management, United States of America

Discussant: Bradley Paye (Virginia Tech)

We develop measures of time-varying risk aversion and economic uncertainty that are calculated from financial variables at high frequencies. We formulate a dynamic no-arbitrage asset pricing model for equities and corporate bonds. The joint dynamics among asset-specific cash flows, macroeconomic fundamentals and risk aversion feature heteroskedasticity and non-Gaussianity. Variance risk premiums on equity are very informative about risk aversion, whereas credit spreads and corporate bond volatility are highly correlated with economic uncertainty. Model-implied risk premiums outperform standard instruments for predicting excess returns on equity and corporate bonds. A financial proxy to our economic uncertainty predicts output growth significantly negatively.

efa2019-APE-2-1316-The Time Variation in Risk Appetite and Uncertainty.pdf

Can unpredictable risk exposure be priced?

Ricardo Barahona, Joost Driessen, Rik Frehen

Tilburg University, Netherlands, The

Discussant: Thomas Dangl (Vienna University of Technology)

We study the link between beta predictability and the price of risk. An investor who desires exposure to a certain risk factor needs to predict what next period’s beta will be. We use a simple model to show that an ambiguity averse agent’s demand is lower when betas are hard to predict, leading to a reduction in risk premiums. We test the implications for downside betas and VIX betas. We find that they have economically and statistically small prices of risk once we account for the fact that an investor cannot observe ex-post realized betas when determining asset demand.

efa2019-APE-2-1626-Can unpredictable risk exposure be priced.pdf

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