The wealth of stagnation: Falling growth, rising valuations
Abstract: Over the last half-century, economic growth stagnated but stock-market wealth boomed. I present evidence that declining innovation productivity reconciles these trends. At the macro level, I document that R&D spending has fallen relative to value, while M&A spending has doubled relative to R&D. At the micro level, most of the increase in aggregate valuation ratios is explained by a reallocation of sales shares toward high-valuation firms. Using a Schumpeterian model of growth and asset prices, I find that declining innovation productivity explains these facts. When innovation productivity falls, R&D falls and M&A rises. This concentrates production into the hands of the most efficient (high-valuation) incumbents, causing aggregate value to boom. Quantitatively, this explains most of the decline in growth and the rise in valuations. It also helps explain other salient trends, including declining firm entry, rising concentration, and falling interest rates. While stock-market wealth boomed, the present value of consumption (consumer welfare) stagnated with output.
Sovereign default and the decline in interest rates
with Max Miller and Jessica A. Wachter
Revise and Resubmit, Review of Financial Studies
Abstract: Sovereign debt yields have declined dramatically over the last half-century. Standard explanations, including aging populations and increases in asset demand from abroad, encounter difficulties when confronted with the full range of evidence. We propose an explanation based on a decline in inflation and default risk, which we argue is more consistent with the long-run nature of the interest rate decline. We show that a model with investment, inventory storage, and sovereign default captures the decline in interest rates, the stability of equity valuation ratios, and the recent reduction in investment and output growth coinciding with the binding zero lower bound.
Interest-rate risk and household portfolios
with Sylvain Catherine, Max Miller, and Natasha Sarin
Reject and Resubmit, American Economic Review
Abstract: How are households exposed to interest-rate risk? When rates fall, households face lower future expected returns but those holding long-term assets—disproportionately the wealthy and middle-aged—experience capital gains. We study the hedging demand for long-term assets in a portfolio choice model. The optimal interest-rate sensitivity of wealth is hump-shaped over the life cycle. Within cohorts, it increases with wealth and earnings. These predictions fit observed patterns in the United States, suggesting a relatively efficient distribution of interest-rate risk. By protecting workers from rate fluctuations, Social Security limits the welfare consequences of rising wealth inequality when rates fall.
What explains wealth and portfolio differences between Black and White Americans?
with Sylvain Catherine and Ellen Lu
Revise and Resubmit, Review of Financial Studies
Abstract: We study how economic and social disparities between Black and White Americans shape the composition of their balance sheets and contribute to the racial wealth gap in a life-cycle model. Our analysis yields three main results. First, environmental disparities fully explain differences in portfolio composition. Second, in a dynamic setting where consumption and portfolio choices are endogenous, negative economic conditions increase saving demand and therefore have a limited impact on the racial wealth gap. In other words, the overall consequence of these disparities on Black wealth is smaller than their direct monetary and welfare costs. Third, progressive programs like Social Security can only explain one-third of the racial wealth gap.
Heterogeneous-agent asset pricing: Timing and pricing idiosyncratic risks
Abstract: This paper studies the importance of idiosyncratic endowment shocks for aggregate asset prices in a generalized continuous-time framework that accommodates both jumps and recursive preferences. I show that, regardless of the presence of jumps, countercyclical cross-sectional risk is irrelevant to risk premia if and only if (i) all agents have time-additive power utility and (ii) cross-sectional risk is uncorrelated with aggregate consumption risk. To quantify the relevance of these conditions, I calibrate a general-equilibrium model with a continuum of recursive-utility agents who face uninsurable idiosyncratic human-capital disasters. The model explains both asset pricing moments and cross-sectional income moments from Social Security Administration income data.
Associative learning and representativeness
with Michael J. Kahana and Jessica A. Wachter
Abstract: The representativeness heuristic constitutes a striking departure from Bayesian updating. According to a strong form of the heuristic, agents reverse a conditioning argument: for example inferring that a patient is more likely than not to have a rare disease, conditional on a positive test result. The correct inference is that a positive test result is more likely than not, conditional on disease. Recent research implicates representativeness in a wide range of financial market anomalies, with potential consequences for the real economy. However, the cognitive foundations of the representativeness heuristic (RH) remain unknown. Here, we show that the RH emerges from a theory of associative memory and recognition, leading to a cognitive foundation for the RH, and a means of integrating the RH into economic models involving decision-making under uncertainty.
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