I investigate empirically the ability of financial market incompleteness to help explaining the equity premium puzzle. I estimate the non-diversifiable component of the cross-sectional volatility of income and examine its cyclical properties. Equipped with these estimates, I compute the implied equilibrium Sharpe-ratio of excess returns and evaluate the ability of idiosyncratic risk to improve ...

In the first essay (joint work with Bryan Routledge), we calculate the value implications of suboptimal capital budgeting decisions in an asset-pricing model calibrated to match the standard asset pricing empirical properties – in particular, the time-variation in the equity premium. Specifically, we calculate that an investment policy that ignores the time variation in the equity premium, such...

The determination of stock prices and equilibrium expected rates of return in a general equilibrium setting is still imperfectly understood. In particular, as Grossman and Shiller (1981) and others have argued, stock returns appear to be too volatile given the smooth process for dividends and consumption growth. Mehra and Prescott (1985) claim that this smoothness in consumption and dividend gr...

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 fundamentals, and fits standard salient features of asset prices including the means and volatilities of equity returns and risk free rates. BEGE dynamics are essential for the ...

To estimate the equity premium, it is helpful to use finance theory: not the old-fashioned theory that efficient markets imply a constant equity premium, but theory that restricts the time-series behavior of valuation ratios, and that links the cross-section of stock prices to the level of the equity premium. Under plausible conditions, valuation ratios such as the dividend-price ratio should n...

To estimate the equity premium, it is helpful to use finance theory: not the old-fashioned theory that efficient markets imply a constant equity premium, but theory that restricts the time-series behavior of valuation ratios, and that links the cross-section of stock prices to the level of the equity premium. Under plausible conditions, valuation ratios such as the dividend-price ratio should n...

We study asset-pricing implications of innovation in a general-equilibrium overlappinggenerations economy. Innovation increases the competitive pressure on existing firms and workers, reducing the profits of existing firms and eroding the human capital of older workers. Due to the lack of inter-generational risk sharing, innovation creates a systematic risk factor, which we call “displacement r...

A canonical two country-two good model with standard preferences does not address three classic international macroeconomic puzzles as well as two well-known asset pricing puzzles. Specifically, under financial autarky, it does not account for the high real exchange rate (RER) volatility relative to consumption volatility (RER volatility puzzle), the negative RER-consumption differentials corre...

As documented in Fama and French (1992), small firms’ expected equity returns are usually larger than big firms.’ Notably, Fama and French (1995) attributed this return pattern, dubbed as size premium, to a notion that small firms are assigned a higher risk premium because they face greater risk of distress. However, “distress anomaly” papers including Campbell, Hilscher, and Szilagyi (2008) em...

Recent tests of stochastic dominance of several orders proposed by Linton, Maasoumi and Whang (2003) are applied to reexamine the equity premium puzzle. An advantage of this nonparametric framework is that it provides a means to assess whether the existence of a premium is due to particular cardinal choices of either the utility function or the underlying returns distribution, or both. The appr...