Local stock markets adjust sluggishly to changes in local inflation. When the local rate of inflation increases, local investors subsequently earn lower real returns on local stocks, but not on local bonds or foreign stocks, suggesting that local stock market investors use sticky long-run nominal discount rates that are too low when inflation increases because they are slow to update the inflation expectations in discount rates. Small amounts of stickiness in inflation expectations suffice to match the real stock return predictability induced by inflation in the data. We also consider other explanations, such as nominal cash flow extrapolation. Received September 14, 2015; editorial decision June 30, 2016 by Editor Stefan Nagel.

We identify a "slope" factor in exchange rates. High interest rate currencies load more on this slope factor than low interest rate currencies. This factor accounts for most of the cross-sectional variation in average excess returns between high and low interest rate currencies. A standard, no-arbitrage model of interest rates with two factors--a country-specific factor and a global factor--can replicate these findings, provided there is sufficient heterogeneity in exposure to global or common innovations. We show that our slope factor identifies these common shocks, and we provide empirical evidence that it is related to changes in global equity market volatility. By investing in high interest rate currencies and borrowing in low interest rate currencies, U.S. investors load up on global risk. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

Three of the most fundamental changes in US corporations since the early 1970s have been (1) the increased importance of organizational capital in production, (2) the increase in managerial income inequality and pay-performance sensitivity, and (3) the secular decrease in labor market reallocation. Our paper develops a simple explanation for these changes: a shift in the composition of productivity growth away from vintage-specific to general growth. This shift has stimulated the accumulation of organizational capital in existing firms and reduced the need for reallocating workers to new firms. We characterize the optimal managerial compensation contract when firms accumulate organizational capital but risk-averse managers cannot commit to staying with the firm. A calibrated version of the model reproduces the increase in managerial compensation inequality and the increased sensitivity of pay to performance in the data over the last three decades. This increased sensitivity of compensation to performance provides large, successful firms with the glue to retain their managers and the organizational capital embedded in them.

We examine the pricing of financial crash insurance during the 2007–2009 financial crisis in US option markets, and we show that a large amount of aggregate tail risk is missing from the cost of financial sector crash insurance during the crisis. The difference in costs between out-of-the-money put options for individual banks and puts on the financial sector index increases four-fold from its precrisis 2003–2007 level. We provide evidence that a collective government guarantee for the financial sector lowers index put prices far more than those of individual banks and explains the increase in the basket-index put spread.

Long Run Risk, the Wealth-Consumption Ratio, and the Temporal Pricing of Risk by Ralph S. J. Koijen, Hanno Lustig, Stijn Van Nieuwerburgh and Adrien Verdelhan. Published in volume 100, issue 2, pages 552-56 of American Economic Review, May 2010

We show that firms׳ idiosyncratic volatility obeys a strong factor structure and that shocks to the common idiosyncratic volatility (CIV) factor are priced. Stocks in the lowest CIV-beta quintile earn average returns 5.4% per year higher than those in the highest quintile. The CIV factor helps to explain a number of asset pricing anomalies. We provide new evidence linking the CIV factor to income risk faced by households. Our findings are consistent with an incomplete markets heterogeneous agent model. In the model, CIV is a priced state variable because an increase in idiosyncratic firm volatility raises the average household׳s marginal utility. The calibrated model matches the high degree of co-movement in idiosyncratic volatilities, the CIV-beta return spread, and several other asset price moments.

Using high‐frequency spending data, we show that household consumption displays excess sensitivity to salient macroeconomic news, even when the news is not real. When the announced local unemployment rate reaches a 12‐month maximum, local news coverage of unemployment increases and local consumers reduce their discretionary spending by 1.5% relative to consumers in areas with the same macroeconomic conditions. Low‐income households display greater excess sensitivity to salience. The decrease in spending is not later reversed. Households in treated areas act as if they are more financially constrained than those in untreated areas with the same fundamentals.

We develop a model of the global financial cycle with one key ingredient: the international demand for safe dollar assets. The model matches patterns of dollar borrowing and currency mismatch, the U.S. external balance sheet, exorbitant privilege, spillovers of the U.S. monetary policy to the rest of the world, and the dollar as a global risk factor. In doing so, we lay out a novel transmission mechanism through which the U.S. monetary policy affects the currency market and the global economy. The global financial cycle is a dollar cycle.

In a monetary union, the risk-free rate cannot adjust to country-level fiscal positions, leaving only default spreads and convenience yields to respond. Empirically, we find that convenience yields explain a large share of the variation in eurozone (EZ) sovereign bond yields. EZ sovereign bonds earn larger convenience yields when their governments run larger surpluses. Since convenience yields generate substantial seigniorage revenue from debt issuance, our estimates imply economically large fiscal costs from low convenience yields for peripheral countries in the EZ.

Across a wide panel of countries, the top-10% of financial stocks on average account for over 20% of a country’s market capitalization but earn on average significantly lower returns than do nonfinancial firms of the same size and risk exposures. In a bailout-augmented, rare disasters asset pricing model, the spread in risk-adjusted returns between large and small institutions depends on country characteristics that determine the likelihood of bailouts. Consistent with this model, we find larger spreads in countries with large and interconnected financial sectors, weaker capital regulation and corporate governance, and fiscally stronger governments. Valuation gaps increase in anticipation of financial crises.