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.
First draft: July 2020 | Current version: March 2023
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.
First draft: March 2021 | Current version: December 2022
Interest-rate risk and household portfolios
with Sylvain Catherine, Max Miller, and Natasha Sarin
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.
First draft: May 2022 | Current version: October 2023
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