This paper establishes the link of microstructure and macroeconomic factors with the timevarying conditional correlation of foreign exchange and excess equity returns. By using the proposed DCC model with exogenous variables, capital flows and interest rate differentials are shown to be significant determinants of this correlation which is inclusive of the short-run variation of both asset retu...

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...

This article develops a framework that combines the economics behind the structural modeling of sovereign credit risk, corporate capital structure, and the equilibrium modeling of international asset pricing. The default decisions of the sovereign and the firm are derived optimally and embedded in a two-country, two-good consumption-based asset-pricing model with a representative risk-averse ag...

Extreme asset price movements appear to be more pronounced over time and have major consequences for an economy’s financial stability and monetary policies. This paper investigates the extreme behaviour of equity market returns and quantifies the probabilities of these losses. Taking fourteen major equity markets the study illustrates similarities and divergences in the tail returns from around...

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 ...

Recent studies in international finance have shown that correlation of international equity returns increases during volatile periods. However, correlation should be used with great care. For example, assuming a multivariate normal distribution with constant correlation, conditional correlation during volatile periods (large absolute returns) is higher than conditional correlation during tranqu...

Previous empirical studies have documented that equity prices react to announcements of unexpected dividend changes. The most promising hypothesis forwarded as an explanation of this phenomenon is the dividend signalling hypothesis. Building on a foundation of dividend signalling models, this study employs an expanded set of explanatory variables to explain excess returns documented around divi...

This paper investigates how financial-sector leverage affects macroeconomic instability and welfare. In the model, banks borrow (use leverage) to allocate resources to productive projects and provide liquidity. When banks do not actively issue new equity, aggregate outcomes depend on the level of equity in the financial sector. Equilibrium is inefficient because agents do not internalize how th...

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...