[Given the cross-sectional and temporal variation in their liquidity, emerging equity markets provide an ideal setting to examine the impact of liquidity on expected returns. Our main liquidity measure is a transformation of the proportion of zero daily firm returns, averaged over the month. We find that it significantly predicts future returns, whereas alternative measures such as turnover do not. Consistent with liquidity being a priced factor, unexpected liquidity shocks are positively correlated with contemporaneous return shocks and negatively correlated with shocks to the dividend yield. We consider a simple asset-pricing model with liquidity and the market portfolio as risk factors and transaction costs that are proportional to liquidity. The model differentiates between integrated and segmented countries and time periods. Our results suggest that local market liquidity is an important driver of expected returns in emerging markets, and that the liberalization process has not fully eliminated its impact.]

Abstract We decompose long-term nominal bond yields into real and inflation components in an international context using inflation-linked and nominal bonds. In contrast to extant results, real rate variation dominates the variation in inflation-linked and nominal yields. Cross-country nominal and inflation-linked yield correlations have declined since the Great Recession. Real rates are the main source of the correlation between nominal yields. Our results are robust to various alternative measurements of inflation expectations and the liquidity premium. They continue to hold when a no-arbitrage term structure model with real, nominal, and inflation factors is used to effect the yield decomposition.

Abstract The equity variance risk premium is the expected compensation earned for selling variance risk in equity markets. The variance risk premium is positive and shows only moderate persistence. High variance risk premiums coincide with the left tail of the consumption growth distribution shifting down. These facts, together with risk-neutral skewness being substantially more negative than physical return skewness, refute the bulk of the extant consumption-based asset pricing models. We introduce a tractable habit model that does fit the data. In the model, the variance risk premium depends positively (or negatively) on “bad” (or “good”) consumption growth uncertainty.

Gallant, Hansen, and Tauchen (1990) show how to use conditioning information optimally to construct a sharper unconditional variance bound (the GHT bound) on pricing kernels. The literature predominantly resorts to a simple but suboptimal procedure that scales returns with predictive instruments and computes standard bounds using the original and scaled returns. This article provides a formal bridge between the two approaches. We propose an optimally scaled bound that coincides with the GHT bound when the first and second conditional moments are known. When these moments are misspecified, our optimally scaled bound yields a valid lower bound for the standard deviation of pricing kernels, whereas the GHT bound does not. We illustrate the behavior of the bounds using a number of linear and nonlinear models for consumption growth and bond and stock returns. We also illustrate how the optimally scaled bound can be used as a diagnostic for the specification of the first two conditional moments of asset returns. Copyright 2004, Oxford University Press.

We examine international stock return comovements using country-industry and country-style portfolios as the base portfolios. We first establish that parsimonious risk-based factor models capture the data covariance structure better than the popular Heston–Rouwenhorst (1994) model. We then establish the following stylized facts regarding stock return comovements. First, there is no evidence for an upward trend in return correlations, except for the European stock markets. Second, the increasing importance of industry factors relative to country factors was a short-lived phenomenon. Third, large growth stocks are more correlated across countries than are small value stocks, and the difference has increased over time.

Building on intuition from the dynamic asset pricing literature, we uncover unobserved risk aversion and fundamental uncertainty from the observed time series of the variance premium and the credit spread while controlling for the conditional variance of stock returns, expectations about the macroeconomic outlook, and interest rates. We apply this methodology to monthly data from both Germany and the US. We find that the variance premium contains a substantial amount of information about risk aversion whereas the credit spread has a lot to say about uncertainty. We link our risk aversion and uncertainty estimates to practitioner and “academic” risk aversion indices, sentiment indices, financial stress indices, business cycle indicators and liquidity measures.

We introduce a “bad environment–good environment” (BEGE) technology for consumption growth in a consumption-based asset pricing model with external habit formation. The model generates realistic non-Gaussian features of consumption growth and fits standard salient features of asset prices including the means and volatilities of equity returns and a low risk-free rate. BEGE dynamics additionally allow the model to generate realistic properties of equity index options prices and their comovements with the macroeconomic outlook. In particular, when option-implied volatility is high—as measured, for instance, by the VIX index—the distribution of consumption growth is more negatively skewed.

We use non-Gaussian features in U.S. macroeconomic data to identify aggregate supply and demand shocks while imposing minimal economic assumptions. Macro risks represent the variables that govern the time-varying variance, skewness, and higher-order moments of these two shocks, with ”good” (”bad”) variance associated with positive (negative) skewness. We document that macro risks significantly contribute to the variation of yields and risk premiums for nominal bonds. While overall bond risk premiums are countercyclical, an increase in aggregate demand variance significantly lowers risk premiums. Macro risks also significantly predict future realized bond return variances.

[We propose a new, valuation-based measure of world equity market segmentation. While we observe decreased levels of segmentation in many countries, the level of segmentation remains significant in emerging markets. We characterize the factors that account for variation in market segmentation both through time as well as across countries. Both a country's regulation with respect to foreign capital flows and certain nonregulatory factors are important. In particular, we identify a country's political risk profile and its stock market development as two additional local segmentation factors as well as the U.S. corporate credit spread as a global segmentation factor.]

We investigate the expectations hypotheses of the term structure of interest rates and of the foreign exchange market using vector autoregressive methods for U.S. dollar, Deutsche mark, and British pound interest rates and exchange rates. We examine Wald, Lagrange multiplier, and distance metric tests by iterating on approximate solutions that require only matrix inversions. Bias‐corrected, constrained VARs provide Monte Carlo simulations. Wald tests grossly overreject the null, Lagrange multiplier tests slightly underreject, and distance metric tests overreject. A common interpretation emerges from the small sample statistics. The evidence against the expectations hypotheses is much less strong than under asymptotic inference.