Asset Pricing in the Stock and Options Markets

This thesis comprises three essays on asset pricing on the stock and options markets. The first essay finds a positive relation between the slope of the volatility term structure and subsequent option returns. The second essay finds a negative relation between realized skewness, extracted from high-frequency data, and stock returns. The third essay finds a negative relation between price jumps of intraday data and future stock returns.

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Heterogeneous Consumption and Asset Pricing in Global Financial Markets

Sergei Sarkissian

This dissertation studies the impact of heterogeneous consumption growth rates across countries on cross-country differences in expected asset returns and tests on the country level the implications of the Constantinides and Duffie (1996) CCAPM which accounts for the investors’ heterogeneity and existence of incomplete markets. The inclusion of the cross-country dispersion of countries’ per-capita consumption growth rates into the standard power utility model has a positive impact on the ability of the model to resolve the risk-free rate, equity premium, and forward premium puzzles. The estimates of the risk aversion parameter are lower, the standard errors are generally smaller, and the time preference parameter decreases towards unity. In addition, the consumption model with  heterogeneity leads to a decrease in the estimates of the Hansen and Jagannathan (1997) distance measure for all types of assets and of most average pricing errors. The tests of the beta pricing relation derived from the original model reveal that more realistic parameter estimates and better overall fit of the new model are achieved primarily due to the negative relation between expected asset returns and the covariance of asset returns with the cross-country consumption dispersion.

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Essays in Macroeconomics and Asset Pricing

In this dissertation Manaenkov study the role recursive preferences due to Epstein and Zin (1989) play in macroeconomics and asset pricing. First, he combine recursive preferences with long-run productivity growth risk and study the implications for asset pricing. Second, he focus on the preference for the timing of resolution of uncertainty that arises when one uses Epstein-Zin recursive utility, and the interaction of such preference with incentives to invest into technology that could cause uncertainty to be realized early. In the first part of this dissertation he setup a monetary production economy with capital accumulation and recursive preferences and evaluate model’s implications for pricing of equity and nominal default-free bonds. Plausibly parameterized model generates equity premium of about 1%, large and positive nominal bond term premium. Equity and nominal bond excess returns are forecastable, but considerably less so than in the data. Model generates large inflation premium, that is fairly sensitive to the parameters of interest rate rule. In the second part I investigate the interaction between government policy and incentives to invest in risk-control technology in a heterogenous preference setting. Empirical studies show that intertemporal elasticity of substitution varies a great deal within population. He setup a stylized model where such heterogeneity leads to difference in preference for the timing of the resolution of uncertainty. The uncertainty in the model is about the future productivity of a risky technology. Investors can choose to observe an early signal about their individual future productivity (hence shifting the resolution of uncertainty to the earlier date) and cut exposure in case of a bad signal via conversion of a part of risky technology investment into safe investment. Government in the model has the power to influence the cost of borrowing and the return of the safe investment. Is how that government policy has important implications both for the individual choice of whether to observe a signal about future productivity and for the aggregate output.

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Essays in Monetary Policy and Asset Pricing

The estimated yield-curve model explains the “snake-shaped” term structure of volatility in yields, based on interest-rate smoothing and policy inertia. Macroeconomic surprises are only temporary components of macro variables. This means that the impact of these surprises on longer yields needs to occur over time through a “policy-inertia factor.” The model improves the fit of bond prices over a 3-latent-factor model, especially for short maturities. A policy rule is identified from weekly yield data and is found to provide a good description of the target. In fact, model-based forecasts of future target rates outperform several benchmarks.

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Essays in Asset Pricing

All asset pricing models, whether of securities, cars or watches, are versions of the basic demand and supply model where prices are determined by the intersection of demand and supply. The demand and supply functions reflect the preferences of consumers and producers. The demand and supply structure is evident in the CAPM. In that model investors on both the demand and supply sides prefer mean-variance-efficient portfolios and the aggregation of their preferences yields an asset pricing model where expected returns of securities vary by beta. The demand and supply structure is not nearly as evident in the Fama and French 3-factor asset pricing model. Market capitalization and book-to-market ratios were associated with anomalies relative to the CAPM long before their debut in the 3-factor model, but the argument that market capitalization and book-to-market ratios proxy for risk is not fully supported by the evidence. The purpose of this paper is to help link asset pricing models to the preferences of investors. We outline a behavioral asset pricing model where expected returns are high when objective risk is high and also when subjective risk is high. High subjective risk comes with negative affect and low subjective risk comes with positive affect. Affect is the specific quality of ‘goodness’ or ‘badness.’ It is a feeling that occurs rapidly and automatically, often without consciousness. Investors prefer stocks with positive affect and their preference boosts the prices of stocks with positive affect and depresses their returns.

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