Nominal Rigidities and Asset PricingBest Finance PhD Award in Honor of Prof. Greenbaum (Finalist)
This paper examines the asset-pricing implications of nominal rigidities. I find that firms that adjust their product prices infrequently earn a cross-sectional return premium of more than 4% per year. Merging confidential product price data at the firm level with stock returns, I document that the premium for sticky-price firms is a robust feature of the data and is not driven by other firm and industry characteristics. The consumption-wealth ratio is a strong predictor of the return differential in the time series, and differential exposure to systematic risk fully explains the premium in the cross section. The sticky-price portfolio has a conditional market beta of 1.3, which is 0.4 higher than the beta of the flexible-price portfolio. The frequency of price adjustment is therefore a strong determinant of the cross section of stock returns. To rationalize these facts, I develop a multi-sector production-based asset-pricing model with sectors differing in their frequency of price adjustment.
Are Sticky Prices Costly? Evidence from the Stock Market
(with Yuriy Gorodnichenko)
Media Coverage: Econbrowser, The Economist, WCEG, DeLong(under review)
We show that after monetary policy announcements, the conditional volatility of stock market returns rises more for firms with stickier prices than for firms with more flexible prices. This differential reaction is economically large as well as strikingly robust to a broad array of checks. These results suggest that menu costs - broadly defined to include physical costs of price adjustment, informational frictions, etc. - are an important factor for nominal price rigidity. We also show that our empirical results are qualitatively and, under plausible calibrations, quantitatively consistent with New Keynesian macroeconomic models where firms have heterogeneous price stickiness. Since our framework is valid for a wide variety of theoretical models and frictions preventing firms from price adjustment, we provide "model-free" evidence that sticky prices are indeed costly.
Online AppendixNBER EFG 2013, NBER SI EFG-PD 2013, ESNASM 2013, Barcelona Summer Forum 2013, BU/ Boston Fed Conference 2013.Other versions: NBER,SSRN Antisemitism Affects Households' Investments
(with Francesco D'Acunto and Marcel Prokopczuk)
We propose historical anti-Jewish sentiment as a proxy for distrust in financial markets. Households in German counties where Jews were persecuted the most as far back as in the Middle Ages are less likely to invest in stocks today. A one-standard-deviation increase in historical anti-Jewish violence leads to a 7.5% to 12% drop in the average stock market participation. For identification, we exploit the forced migrations of Ashkenazi Jews out of the Rhine Valley after the 11th century. The distance of a county from the Rhine Valley instruments for the existence of a Jewish community during the Black Death (1349) and hence the early emergence of anti-Jewish sentiment. Results are similar when we use the votes for the Nazi party as a proxy for anti-Jewish sentiment. The magnitude of the effect does not change from 1984 until 2011 nor across cohorts. Anti-Jewish sentiment does not capture generalized trust: its effect on stockholdings is similar across counties and households with different levels of education.
The Term Structure of Equity Returns: Risk or Mispricing? Finalist of the 2013 Dr. Richard A. Crowell Memorial Prize
The term structure of equity returns is downward sloping. High duration stocks, whose cashflows are concentrated in the future, earn lower returns than low duration stocks. I provide evidence consistent with temporary overpricing of short sale constrained, high duration stocks. Using institutional ownership as a proxy for short sale constraints, I find that low returns of high duration stocks are contained within short sale constrained portfolios: the spread in Fama & French alphas between low and high duration portfolios is 1.52% per month for the most constrained stocks. This difference is monotonically decreasing with less binding short sale constraints to an insignificant 0.29% per month for the least short sale constrained stocks. These effects are stronger after periods of high investor sentiment, leading support to sentiment-based overpricing when short sale constraints keep sophisticated investors out of the market. These findings are independent of size and book to market.
Conditional Risk Premia in Currency Markets and Other Asset Classes
(with Martin Lettau and Matteo Maggiori)Winner of the 2013 AQR Insight Award
Media Coverage: AQR Announcement,WSJ, Reuters Journal of Financial Economics (forthcoming)
The downside risk CAPM (DR-CAPM) can price the cross section of currency returns. The market-beta differential
between high and low interest rate currencies is higher conditional on bad market returns,
when the market price of risk is also high, than it is conditional on good market returns.
Correctly accounting for this variation is crucial for the empirical performance of the model.
The DR-CAPM can jointly explain the cross section of equity, commodity, sovereign bond and currency returns,
thus offering a unified risk view of these asset classes. In contrast,
popular models that have been developed for a specific asset class fail to jointly price other asset classes.
Online Appendix, DataAEA 2012, EFA 2012, EEA 2012, ESNAWM 2013, AQR 2013, NBER AP 2013, Finance Cavalcade 2013, Imperical College FX Conference 2013.Other versions: NBER,CEPR,SSRN American Option Valuation: Implied Calibration of GARCH Pricing--Models
(with Marcel Prokopczuk)
SEW Eurodrive Award for Best Undergraduate Thesis in Business Economics Journal of Futures Markets (2011), 31(10): 971--994.
This article analyzes the issue of American option valuation when the underlying
exhibits a GARCH-type volatility process. We propose the usage of Rubinstein's
Edgeworth binomial tree (EBT) in contrast to simulation-based methods being
considered in previous sudies. The EBT-based valuation approach makes an implied
calibration of the pricing model feasible. By empirically analyzing the pricing
performance of American index and equity options, we illustrate the superiority
of the proposed approach.
FMA EM 2010.