John C. Heaton

Consumption Strikes Back? Measuring Long-Run Risk
Date Posted:Thu, 16 Feb 2017 12:49:44 -0600
We characterize and measure a long-term risk-return trade-off for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This trade-off features risk prices of cash flows that are realized far into the future but continue to be reflected in asset values. We apply this analysis to claims on aggregate cash flows and to cash flows from value and growth portfolios by imputing values to the long-run dynamic responses of cash flows to macroeconomic shocks. We explore the sensitivity of our results to features of the economic valuation model and of the model cash flow dynamics.

New: Consumption Strikes Back? Measuring Long-Run Risk
Date Posted:Thu, 16 Feb 2017 02:49:44 -0600
We characterize and measure a long-term risk-return trade-off for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This trade-off features risk prices of cash flows that are realized far into the future but continue to be reflected in asset values. We apply this analysis to claims on aggregate cash flows and to cash flows from value and growth portfolios by imputing values to the long-run dynamic responses of cash flows to macroeconomic shocks. We explore the sensitivity of our results to features of the economic valuation model and of the model cash flow dynamics.

Intangible Risk?
Date Posted:Thu, 19 Dec 2013 10:45:39 -0600
In this paper we reviewed two findings pertinent for using asset market data to make inferences about the intangible capital stock. We presented evidence familiar from the empirical finance literature that returns are heterogeneous when firms are grouped according to their ratio of market equity to book equity. This evidence suggests that there are important differences in the riskiness of investment in measured capital vis-?-vis intangible capital. This has potentially important ramifications for how to build explicit economic models to use in constructing measurements of the intangible capital stock.

New: Intangible Risk?
Date Posted:Thu, 19 Dec 2013 00:45:40 -0600
In this paper we reviewed two findings pertinent for using asset market data to make inferences about the intangible capital stock. We presented evidence familiar from the empirical finance literature that returns are heterogeneous when firms are grouped according to their ratio of market equity to book equity. This evidence suggests that there are important differences in the riskiness of investment in measured capital vis-à-vis intangible capital. This has potentially important ramifications for how to build explicit economic models to use in constructing measurements of the intangible capital stock.

REVISION: Introduction to Review of Financial Studies Conference on Market Frictions and Behavioral Finance
Date Posted:Wed, 16 Dec 2009 06:46:26 -0600
A significant fraction of research by financial economists over the last few decades has attempted to understand various anomalous or puzzling empirical observations taken from financial markets. These range from the equity premium puzzle at the aggregate level, to the small firm effect, to moment in returns, and to post-event abnormal returns at the level of individual stock and portfolio returns. In each case these empirical puzzles are identified by finding portfolios with average ...

Econometric Evaluation of Asset Pricing Models
Date Posted:Thu, 19 Mar 2009 14:39:53 -0500
In this paper we provide econometric tools for the evaluation of intertemporal asset pricing models using specification-error and volatility bounds. We formulate analog estimators of these bounds, give conditions for consistency and derive the limiting distribution of these estimators. The analysis incorporates market frictions such as short-sale constraints and proportional transactions costs. Among several applications we show how to use the methods to assess specific asset pricing models ...

Econometric Evaluation of Asset Pricing Models
Date Posted:Fri, 14 Mar 2008 11:57:53 -0500
In this paper we provide econometric tools for the evaluation of intertemporal asset pricing models using specification-error and volatility bounds. We formulate analog estimators of these bounds, give conditions for consistency and derive the limiting distribution of these estimators. The analysis incorportes market frictions such as short-sale constraints and proportional transactions costs. Among several applications we show how to use the methods to assess specific asset pricing models ...

New: Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing
Date Posted:Wed, 15 Aug 2007 00:24:30 -0500
No abstract is available for this paper.

Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing
Date Posted:Wed, 15 Aug 2007 00:00:00 -0500
We examine asset prices and consumption patterns in a model in which agents face both aggregate and idiosyncratic income shocks, and insurance markets are incomplete. Agents reduce consumption variability by trading in a stock and bond market to offset idiosyncratic shocks, but transactions costs in both markets limit the extent of trade. To calibrate the model, we estimate an empirical model of labor and dividend income, using data from the PSID and the NIPA. Although the agents in the model are not very risk averse, the model predicts a sizable equity premium and a low riskfree rate. By simultaneously considering aggregate and idiosyncratic shocks, we decompose this effect of transactions costs on the equity premium into two components. The direct effect is due to the fact that individuals equate net-of-cost margins, so an asset with lower associated transactions costs will have a lower market rate of return. A second, indirect effect occurs because transactions costs result in individual consumption that more closely tracks individual income than aggregate consumption.

Consumption Strikes Back?: Measuring Long-Run Risk
Date Posted:Tue, 09 Aug 2005 23:45:43 -0500
We characterize and measure a long-run risk return tradeoff for the valuation of financial cash flows that are exposed to fluctuations in macroeconomic growth. This tradeoff features components of financial cash flows that are only realized far into the future but are still reflected in current asset values. We use the recursive utility model with empirical inputs from vector autoregressions to quantify this relationship; and we study the long-run risk differences in aggregate securities and in portfolios constructed based on the ratio of book equity to market equity. Finally, we explore the resulting measurement challenges and the implied sensitivity to alternative specifications of stochastic growth.

Consumption Strikes Back?: Measuring Long-Run Risk
Date Posted:Tue, 09 Aug 2005 14:45:43 -0500
We characterize and measure a long-run risk return tradeoff for the valuation of financial cash flows that are exposed to fluctuations in macroeconomic growth. This tradeoff features components of financial cash flows that are only realized far into the future but are still reflected in current asset values. We use the recursive utility model with empirical inputs from vector autoregressions to quantify this relationship; and we study the long-run risk differences in aggregate securities and ...

Introduction to Review of Financial Studies Conference on Market Frictions and Behavioral Finance
Date Posted:Thu, 14 Apr 2005 00:00:00 -0500
A significant fraction of research by financial economists over the last few decades has attempted to understand various anomalous or puzzling empirical observations taken from financial markets. These range from the equity premium puzzle at the aggregate level, to the small firm effect, to moment in returns, and to post-event abnormal returns at the level of individual stock and portfolio returns. In each case these empirical puzzles are identified by finding portfolios with average returns that are high relative to their risk as measured by the covariance of the returns with the market portfolio, as in the CAPM, or with aggregate consumption, as in the consumption-based CAPM. If the assumptions about market structure and the behavior of agents justifying the models are correct, then return observations imply that agents should trade to take advantage of the observed patterns in returns. There have been essentially three types of explanations put forward for why agents don't take advantage of the anomalies.

REVISION: Introduction to Review of Financial Studies Conference on Market Frictions and Behavioral Finance
Date Posted:Wed, 13 Apr 2005 19:59:46 -0500
A significant fraction of research by financial economists over the last few decades has attempted to understand various anomalous or puzzling empirical observations taken from financial markets. These range from the equity premium puzzle at the aggregate level, to the small firm effect, to moment in returns, and to post-event abnormal returns at the level of individual stock and portfolio returns. In each case these empirical puzzles are identified by finding portfolios with average ...

Portfolio Choice in the Presence of Background Risk
Date Posted:Mon, 22 Jan 2001 14:52:08 -0600
In this paper, we focus on how the presence of background risks - from sources such as labour and entrepreneurial income - influences portfolio allocations. This interaction is explored in a theoretical model that is calibrated using cross-sectional data from a variety of sources. The model is shown to be consistent with some but not all aspects of cross-sectional observations of portfolio holdings. The paper also provides a survey of the extensive theoretical and empirical literature on portfolio choice.

Portfolio Choice in the Presence of Background Risk
Date Posted:Mon, 22 Jan 2001 04:52:08 -0600
In this paper, we focus on how the presence of background risks - from sources such as labour and entrepreneurial income - influences portfolio allocations. This interaction is explored in a theoretical model that is calibrated using cross-sectional data from a variety of sources. The model is shown to be consistent with some but not all aspects of cross-sectional observations of portfolio holdings. The paper also provides a survey of the extensive theoretical and empirical literature on ...

Econometric Evaluation of Asset Pricing Models
Date Posted:Mon, 24 Jul 2000 00:00:00 -0500
In this paper we provide econometric tools for the evaluation of intertemporal asset pricing models using specification-error and volatility bounds. We formulate analog estimators of these bounds, give conditions for consistency and derive the limiting distribution of these estimators. The analysis incorportes market frictions such as short-sale constraints and proportional transactions costs. Among several applications we show how to use the methods to assess specific asset pricing models and to provide nonparametric characterizations of asset pricing anomalies.

Econometric Evaluation of Asset Pricing Models
Date Posted:Sat, 29 Aug 1998 00:00:00 -0500
In this paper we provide econometric tools for the evaluation of intertemporal asset pricing models using specification-error and volatility bounds. We formulate analog estimators of these bounds, give conditions for consistency and derive the limiting distribution of these estimators. The analysis incorporates market frictions such as short-sale constraints and proportional transactions costs. Among several applications we show how to use the methods to assess specific asset pricing models and to provide nonparametric characterizations of asset pricing anomalies.

Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing
Date Posted:Sun, 12 Apr 1998 09:03:54 -0500
We examine an economy with aggregate and idiosyncratic income risk in which agents cannot contract on future labor income. Agents trade financial securities to buffer idiosyncratic shocks, but the extent of trade is limited by borrowing constraints and transactions costs. The effect of frictions on the equity premium is decomposed into two components: a direct effect due to the equation of net-of-costs margins and an indirect effect due to increased consumption volatility. Simulations suggest ...

Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing
Date Posted:Wed, 11 Sep 1996 00:00:00 -0500
We examine an economy with aggregate and idiosyncratic income risk in which agents cannot contract on future labor income. Agents trade financial securities to buffer idiosyncratic shocks, but the extent of trade is limited by borrowing constraints and transactions costs. The effect of frictions on the equity premium is decomposed into two components: a direct effect due to the equation of net-of-costs margins and an indirect effect due to increased consumption volatility. Simulations suggest that the direct effect dominates and that the model predicts a sizable equity premium only if costs are large or the quantity of tradable assets is limited.