Working Papers

Heterogeneous-agent asset pricing

Abstract: When does idiosyncratic consumption risk matter for asset returns? This paper provides an answer in a comprehensive framework with jumps and heterogeneous recursive preferences. While cross-sectional consumption risk always affects the riskfree interest rate and equity volatility, it is irrelevant to risk premia in partial equilibrium if and only if all agents have additively separable preferences. It is irrelevant to risk premia in general equilibrium if and only if all agents have identical power utility and cross-sectional risk is uncorrelated with aggregate consumption risk. The paper also solves explicitly for asset prices in a tractable special case of isoelastic recursive preferences. To illustrate the applicability of the framework, I solve a general equilibrium model in which recursive-utility agents can only invest in a riskfree bond, a stock, and their own inalienable human capital, subject to countercyclical risk of an idiosyncratic disaster.

First draft: March 2021 | Current version: March 2021

Sovereign default and the decline in interest rates

with Max Miller and Jessica A. Wachter

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: February 2021