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APT-3: Equilibrium Models in Asset Pricing
A Unified Model of Distress Risk Puzzles
1Boston University, CEPR, and ECGI; 2Chinese University of Hong Kong; 3Graduate School of Business, Stanford University, and NBER
We build a dynamic model to link two empirical patterns: the negative failure probability-return relation (Campbell, Hilscher, and Szilagyi, 2008) and the positive distress risk premium-return relation (Friewald, Wagner, and Zechner, 2014). We show analytically and quantitatively that (i) procyclical debt financing in highly distressed firms results in a negative covariance between levered equity beta with countercyclical market risk premium; (ii) the negative covariance generates low or negative stock returns and alphas among those highly distressed firms in the conditional CAPM; and (iii) firms with lower distress risk premiums endogenously choose higher leverage, so they are more likely to become distressed and earn negative returns. We provide empirical evidence to support our model predictions.
Asset Prices and Unemployment Fluctuations
1Banque de France; 2Stanford University and Federal Reserve Bank of Minneapolis; 3New York University; 4Hoover Institution Stanford University
We re-examine the problem that textbook search-and-matching models cannot generate anywhere near the observed magnitude of business cycle frequency fluctuations in job-finding rates and unemployment rates in response to shocks of a plausible magnitude. We argue that hiring of a worker is a risky investment for a firm that generate long duration flows of surpluses from the match between a worker and a firm. We capture this idea allowing a worker's human capital to accumulate on the job in a way that is consistent with the micro evidence and we use preferences borrowed from the macro-finance literature that have been successful in generating fluctuations in observed asset prices. When we combine these two features then fluctuations in market productivity generate large fluctuations in the present value of the surplus from a match. For quantitatively relevant amounts of human capital accumulation and specifications of preferences, our model generates fluctuations in the both job-finding rates and unemployment rates similar to those in the data. We argue that our mechanism works very differently than the existing mechanism in the literature that address these issues.
1Columbia University; 2University of Chicago, United States of America
Many stylized facts of leverage, trading, and asset prices obtain in a frictionless general equilibrium model that features agents’ heterogeneity in endowments and time-varying risk preferences. Our model predicts that aggregate debt increases in expansions when asset prices are high, volatility is low, and levered households enjoy a “consumption boom.” Our model is consistent with poorer households borrowing more and with intermediaries’ leverage being a priced factor. In crises, levered households strongly delever by “fire selling” their risky assets as asset prices drop. Yet, as empirically observed, their debt-to-wealth ratios increase as higher discount rates make their wealth decline faster.
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