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John Y. Campbell's
Scholarly Papers
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7,088 |
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1.
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Bad Beta, Good Beta
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John Y. Campbell Harvard University - Department of Economics Tuomo Vuolteenaho Arrowstreet Capital, LP
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23 Oct 02
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16 Oct 03
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2,858 ( 738) |
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John Y. Campbell Harvard University - Department of Economics Tuomo Vuolteenaho Arrowstreet Capital, LP
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25 Feb 03
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26 Feb 03
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This paper explains the size and value 'anomalies' in stock returns using an economically motivated two-beta model. We break the CAPM beta of a stock with the market portfolio into two components, one reflecting news about the market's future cash flows and one reflecting news about the market's discount rates. Intertemporal asset pricing theory suggests that the former should have a higher price of risk; thus beta, like cholesterol, comes in 'bad' and 'good' varieties. Empirically, we find that value stocks and small stocks have considerably higher cash-flow betas than growth stocks and large stocks, and this can explain their higher average returns. The poor performance of the CAPM since 1963 is explained by the fact that growth stocks and high-past-beta stocks have predominantly good betas with low risk prices.
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John Y. Campbell Harvard University - Department of Economics Tuomo Vuolteenaho Arrowstreet Capital, LP
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23 Oct 02
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16 Oct 03
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2,732
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Abstract:
This paper explains the size and value "anomalies" in stock returns using an economically motivated two-beta model. We break the CAPMbeta of a stock with the market portfolio into two components, one reflecting news about the market's future cash flows and one reflecting news about the market's discount rates. Intertemporal asset pricing theory suggests that the former should have a higher price of risk; thus beta, like cholesterol, comes in "bad" and "good" varieties. Empirically, we find that value stocks and small stocks have considerably higher cash-flow betas than growth stocks and large stocks, and this can explain their higher average returns. The poor performance of the CAPMsince 1963 is explained by the fact that growth stocks and high-past-beta stocks have predominantly good betas with low risk prices.
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2.
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John Y. Campbell Harvard University - Department of Economics
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29 Oct 02
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29 Oct 02
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1,961 (1,478)
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This chapter reviews the behavior of financial asset prices in relation to consumption. The chapter lists some important stylized facts that characterize US data, and relates them to recent developments in equilibrium asset pricing theory. Data from other countries are examined to see which features of the US experience apply more generally. The chapter argues that to make sense of asset market behavior one needs a model in which the market price of risk is high, time-varying, and correlated with the state of the economy. Models that have this feature, including models with habit-formation in utility heterogeneous investors, and irrational expectations, are discussed. The main focus is on stock returns and short-term real interest rates, but bond returns are also considered.
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John Y. Campbell Harvard University - Department of Economics Martin Lettau Haas School of Business Burton G. G. Malkiel Princeton University - Bendheim Center for Finance Yexiao Xu University of Texas at Dallas - School of Management
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25 Feb 00
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30 Apr 08
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1,611 (2,137)
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This paper uses a disaggregated approach to study the volatility of common stocks at the market, industry, and firm levels. Over the period 1962-97 there has been a noticeable increase in firm-level volatility relative to market volatility. Accordingly, correlations among individual stocks and the explanatory power of the market model for a typical stock have declined, while the number of stocks needed to achieve a given level of diversification has increased. All the volatility measures move together countercyclically and help to predict GDP growth. Market volatility tends to lead the other volatility series. Factors that may be responsible for these findings are suggested.
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4.
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Equity Volatility and Corporate Bond Yields
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John Y. Campbell Harvard University - Department of Economics Glen B. Taksler affiliation not provided to SSRN
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Posted:
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20 Feb 02
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26 Nov 03
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1,308 ( 3,104) |
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John Y. Campbell Harvard University - Department of Economics Glen B. Taksler affiliation not provided to SSRN
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24 May 02
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24 May 02
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This paper explores the effect of equity volatility on corporate bond yields. Panel data for the late 1990's show that idiosyncratic firm-level volatility can explain as much cross-sectional variation in yields as can credit ratings. This finding, together with the upward trend in idiosyncratic equity volatility documented by Campbell, Lettau, Malkiel, and Xu (2001), helps to explain recent increases in corporate bond yields.
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John Y. Campbell Harvard University - Department of Economics Glen B. Taksler affiliation not provided to SSRN
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20 Feb 02
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26 Nov 03
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1,240
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Abstract:
This paper explores the effect of equity volatility on corporate bond yields. Panel data for the late 1990's show that idiosyncratic firm-level volatility can explain as much cross-sectional variation in yields as can credit ratings. This finding, together with the upward trend in idiosyncratic equity volatility documented by Campbell, Lettau, Malkiel, and Xu (2001), helps to explain recent increases in corporate bond yields.
Corporate bonds, equity volatility
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5.
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Efficient Tests of Stock Return Predictability
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John Y. Campbell Harvard University - Department of Economics Motohiro Yogo University of Pennsylvania - Finance Department
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23 Oct 02
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28 Aug 09
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1,215 ( 3,539) |
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John Y. Campbell Harvard University - Department of Economics Motohiro Yogo University of Pennsylvania - Finance Department
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14 Oct 03
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28 Aug 09
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Conventional tests of the predictability of stock returns could be invalid, that is reject the null too frequently, when the predictor variable is persistent and its innovations are highly correlated with returns. We develop a pretest to determine whether the conventional t-test leads to invalid inference and an efficient test of predictability that corrects this problem. Although the conventional t-test is invalid for the dividend-price and smoothed earnings-price ratios, our test finds evidence for predictability. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to valid inference.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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John Y. Campbell Harvard University - Department of Economics Motohiro Yogo University of Pennsylvania - Finance Department
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23 Oct 02
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17 Jun 09
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1,164
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Abstract:
Conventional tests of the predictability of stock returns could be invalid, that is reject the null too frequently, when the predictor variable is persistent and its innovations are highly correlated with returns. We develop a pretest to determine whether the conventional t-test leads to invalid inference and an efficient test of predictability that corrects this problem. Although the conventional t-test is invalid for the dividend-price and smoothed earnings-price ratios, our test finds evidence for predictability. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to valid inference.
Bonferroni test, Dividend yield, Predictability, Stock returns, Unit root
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6.
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In Search of Distress Risk
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John Y. Campbell Harvard University - Department of Economics Jens Hilscher Brandeis University - International Business School Jan Szilagyi Duquesne Capital Management LLC
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Posted:
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28 Jul 05
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15 Sep 06
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1,016 ( 4,806) |
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John Y. Campbell Harvard University - Department of Economics Jens Hilscher Brandeis University - International Business School Jan Szilagyi Duquesne Capital Management LLC
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20 Jul 06
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15 Sep 06
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This paper explores the determinants of corporate failure and the pricing of financially distressed stocks using US data over the period 1963 to 2003. Firms with higher leverage, lower profitability, lower market capitalization, lower past stock returns, more volatile past stock returns, lower cash holdings, higher market-book ratios, and lower prices per share are more likely to file for bankruptcy, be delisted, or receive a D rating. When predicting failure at longer horizons, the most persistent firm characteristics, market capitalization, the market-book ratio, and equity volatility become relatively more significant. Our model captures much of the time variation in the aggregate failure rate. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small-cap risk factors than stocks with a low risk of failure. These patterns hold in all size quintiles but are particularly strong in smaller stocks. They are inconsistent with the conjecture that the value and size effects are compensation for the risk of financial distress.
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John Y. Campbell Harvard University - Department of Economics Jens Hilscher Brandeis University - International Business School Jan Szilagyi Duquesne Capital Management LLC
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28 Jul 05
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08 Aug 05
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Abstract:
This paper explores the determinants of corporate failure and the pricing of financially distressed stocks using US data over the period 1963 to 2003. Firms with higher leverage, lower profitability, lower market capitalization, lower past stock returns, more volatile past stock returns, lower cash holdings, higher market-book ratios, and lower prices per share are more likely to file for bankruptcy, be delisted, or receive a D rating. When predicting failure at longer horizons, the most persistent firm characteristics, market capitalization, the market-book ratio, and equity volatility become relatively more significant. Our model captures much of the time variation in the aggregate failure rate. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small-cap risk factors than stocks with a low risk of failure. These patterns hold in all size quintiles but are particularly strong in smaller stocks. They are inconsistent with the conjecture that the value and size effects are compensation for the risk of financial distress.
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7.
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Who Should Buy Long-Term Bonds?
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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Posted:
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01 Dec 98
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19 Nov 08
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952 ( 5,348) |
109
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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10 Jun 00
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17 Apr 08
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According to conventional wisdom, long-term bonds are appropriate for long-term investors who value stability of income. We develop a model of optimal consumption and portfolio choice for infinitely-lived investors facing stochastic interest rates, solve it using an approximate analytical method, and evaluate the conventional wisdom. We show that the demand for long-term bonds has both a myopic component and an intertemporal hedging component. As risk aversion increases, the myopic component shrinks to zero but the hedging component does not. An infinitely risk-averse investor who is infinitely unwilling to substitute consumption intertemporally should hold a portfolio of long-term indexed bonds that is equivalent to an indexed perpetuity. This portfolio finances a riskless consumption stream and in this sense provides a stable income. We calibrate our model to postwar US data and compare consumption and portfolio rules with and without bond indexation, portfolio constraints, and the possibility of investment in equities. We find that when indexed bonds are not available, inflation risk leads investors to shorten their bond portfolios and increase their precautionary savings. This has serious welfare costs for conservative investors, who are much better off when they have the opportunity to buy indexed bonds. We also find that the ratio of bonds to equities in the optimal portfolio increases with the coefficient of relative risk aversion, which is consistent with conventional portfolio advice but inconsistent with the mutual fund theorem of static portfolio analysis. Our results illustrate the general point that static portfolio choice models should not be used to study the dynamic problems facing long-term investors.
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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01 Dec 98
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19 Nov 08
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922
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Abstract:
According to conventional wisdom, long-term bonds are appropriate for long-term investors who value stability of income. We develop a model of optimal consumption and portfolio choice for infinitely-lived investors facing stochastic interest rates, solve it using an approximate analytical method, and evaluate the conventional wisdom. We show that the demand for long-term bonds has both a myopic component and an intertemporal hedging component. As risk aversion increases, the myopic component shrinks to zero but the hedging component does not. An infinitely risk-averse investor who is infinitely unwilling to substitute consumption intertemporally should hold a portfolio of long-term indexed bonds that is equivalent to an indexed perpetuity. This portfolio finances a riskless consumption stream and in this sense provides a stable income. We calibrate our model to postwar US data and compare consumption and portfolio rules with and without bond indexation, portfolio constraints, and the possibility of investment in equities. We find that when indexed bonds are not available, inflation risk leads investors to shorten their bond portfolios and increase their precautionary savings. This has serious welfare costs for conservative investors, who are much better off when they have the opportunity to buy indexed bonds. We also find that the ratio of bonds to equities in the optimal portfolio increases with the coefficient of relative risk aversion, which is consistent with conventional portfolio advice but inconsistent with the mutual fund theorem of static portfolio analysis. Our results illustrate the general point that static portfolio choice models should not be used to study the dynamic problems facing long-term investors.
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8.
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John Y. Campbell Harvard University - Department of Economics John H. Cochrane University of Chicago Booth School of Business
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26 Jun 97
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19 Mar 09
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896 (5,959)
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We present a consumption-based model that explains the procyclical variation of stock prices, the long-horizon predictability of excess stock returns, and the countercyclical variation of stock market volatility. Our model has an i.i.d. consumption growth driving process, and adds a slow-moving external habit to the standard power utility function. The latterfeature produces cyclical variation in risk aversion, and hence in the prices of risky assets. Our model also predicts many of the difficulties that beset the standard power utility model, including Euler equation rejections, no correlation between mean consumption growth and interest rates, very high estimates of risk aversion, and pricing errors that are larger than those of the static CAPM. Our model captures much of the history of stock prices, given only consumption data. Since our model captures the equity premium, it implies that fluctuations have important welfare costs. Unlike many habit-persistence models, our model does not necessarily produce cyclical variation in the risk free interest rate, nor does it produce an extremely skewed distribution or negative realizations of the marginal rate of substitution.
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Stock Market Mean Reversion and the Optimal Equity Allocation of a Long-Lived Investor
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School Francisco J. Gomes London Business School Pascal J. Maenhout INSEAD - Finance Luis M. Viceira Harvard Business School - Finance Unit
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01 Aug 00
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18 Nov 08
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802 ( 7,103) |
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School Francisco J. Gomes London Business School Pascal J. Maenhout INSEAD - Finance Luis M. Viceira Harvard Business School - Finance Unit
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10 Apr 02
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18 Nov 08
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This paper solves numerically the intertemporal consumption and portfolio choice problem of an infinitely-lived investor who faces a time-varying equity premium. The solutions we obtain are very similar to the approximate analytical solutions of Campbell and Viceira (1999), except at the upper extreme of the state space where both the numerical consumption and portfolio rules flatten out. We also consider a constrained version of the problem in which the investor faces borrowing and short-sales restrictions. These constraints bind when the equity premium moves away from its mean in either direction, and are particularly severe for risk-tolerant investors. The constraints have substantial effects on optimal consumption, but much more modest effects on optimal portfolio choice in the region of the state space where they are not binding.
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School Francisco J. Gomes London Business School Pascal J. Maenhout INSEAD - Finance Luis M. Viceira Harvard Business School - Finance Unit
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01 Aug 00
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18 Nov 08
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802
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Abstract:
This paper solves numerically the intertemporal consumption and portfolio choice problem of an infinitely-lived investor who faces a time-varying equity premium. The solutions we obtain are very similar to the approximate analytical solutions of Campbell and Viceira (1999), except at the upper extreme of the state space where both the numerical consumption and portfolio rules flatten out. We also consider a constrained version of the problem in which the investor faces borrowing and short-sales constraints. These constraints bind when the equity premium moves away from its mean in either direction, and are particularly severe for risk-tolerant investors. The optimal constrained portfolio rules are similar but not identical to the optimal unconstrained rules with the constraints imposed. The portfolio constraints also affect the optimal consumption policy.
Hedging Demand, Intertemporal Portfolio Choice, And Mean Reversion
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10.
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Asset Pricing At The Millennium
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John Y. Campbell Harvard University - Department of Economics
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Posted:
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09 Jul 00
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02 Oct 08
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783 ( 7,366) |
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John Y. Campbell Harvard University - Department of Economics
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01 Aug 00
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23 Aug 00
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This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work, and on the tradeoff between risk and return. Modern research seeks to understand the behavior of the stochastic discount factor (SDF) that prices all assets in the economy. The behavior of the term structure of real interest rates restricts the conditional mean of the SDF, while patterns of risk premia restrict its conditional volatility and factor structure. Stylized facts about interest rates, aggregate stock prices, and cross-sectional patterns in stock returns have stimulated new research on optimal portfolio choice, intertemporal equilibrium models, and behavioral finance.
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John Y. Campbell Harvard University - Department of Economics
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06 Sep 00
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02 Oct 08
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Abstract:
This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work, and on the tradeoff between risk and return. Modern research seeks to understand the behavior of the stochastic discount factor (SDF) that prices all assets in the economy. The behavior of the term structure of real interest rates restricts the conditional mean of the SDF, while patterns of risk premia restrict its conditional volatility and factor structure. Stylized facts about interest rates, aggregate stock prices, and cross-sectional patterns in stock returns have stimulated new research on optimal portfolio choice, intertemporal equilibrium models, and behavioral finance.
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John Y. Campbell Harvard University - Department of Economics
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09 Jul 00
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This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work, and on the tradeoff between risk and return. Modern research seeks to understand the behavior of the stochastic discount factor (SDF) that prices all assets in the economy. The behavior of the term structure of real interest rates restricts the conditional mean of the SDF, while patterns of risk premia restrict its conditional volatility and factor structure. Stylized facts about interest rates, aggregate stock prices, and cross-sectional patterns in stock returns have stimulated new research on optimal portfolio choice, intertemporal equilibrium models, and behavioral finance.
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11.
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Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns
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John Y. Campbell Harvard University - Department of Economics Christopher K. Polk London School of Economics Tuomo Vuolteenaho Arrowstreet Capital, LP
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06 Jul 05
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22 Mar 06
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John Y. Campbell Harvard University - Department of Economics Christopher K. Polk London School of Economics Tuomo Vuolteenaho Arrowstreet Capital, LP
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22 Mar 06
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The cash flows of growth stocks are particularly sensitive to temporary movements in aggregate stock prices (driven by movements in the equity risk premium), while the cash flows of value stocks are particularly sensitive to permanent movements in aggregate stock prices (driven by market-wide shocks to cash flows.) Thus the high betas of growth stocks with the market's discount-rate shocks, and of value stocks with the market's cash-flow shocks, are determined by the cash-flow fundamentals of growth and value companies. Growth stocks are not merely "glamour stocks" whose systematic risks are purely driven by investor sentiment. More generally, accounting measures of firm-level risk have predictive power for firms' betas with market-wide cash flows, and this predictive power arises from the behavior of firms' cash flows. The systematic risks of stocks with similar accounting characteristics are primarily driven by the systematic risks of their fundamentals.
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John Y. Campbell Harvard University - Department of Economics Christopher K. Polk London School of Economics Tuomo Vuolteenaho Arrowstreet Capital, LP
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The cash flows of growth stocks are particularly sensitive to temporary movements in aggregate stock prices (driven by movements in the equity risk premium), while the cash flows of value stocks are particularly sensitive to permanent movements in aggregate stock prices (driven by market-wide shocks to cash flows.) Thus the high betas of growth stocks with the market's discount-rate shocks, and of value stocks with the market's cash-flow shocks, are determined by the cash-flow fundamentals of growth and value companies. Growth stocks are not merely "glamour stocks" whose systematic risks are purely driven by investor sentiment. More generally, accounting measures of firm-level risk have predictive power for firms' betas with market-wide cash flows, and this predictive power arises from the behavior of firms' cash flows. The systematic risks of stocks with similar accounting characteristics are primarily driven by the systematic risks of their fundamentals.
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Strategic Asset Allocation in a Continuous-Time VAR Model
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John Y. Campbell Harvard University - Department of Economics George Chacko Harvard Business School Jorge F. Rodriguez Merrill Lynch Luis M. Viceira Harvard Business School - Finance Unit
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24 Oct 02
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27 Oct 09
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695 ( 8,862) |
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John Y. Campbell Harvard University - Department of Economics George Chacko Harvard Business School Jorge F. Rodriguez Merrill Lynch Luis M. Viceira Harvard Business School - Finance Unit
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12 Jan 04
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30 Jan 04
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This Paper derives an approximate solution to a continuous-time intertemporal portfolio and consumption choice problem. The problem is the continuous-time equivalent of the discrete-time problem studied by Campbell and Viceira (1999), in which the expected excess return on a risky asset follows an AR(1) process, while the riskless interest rate is constant. The Paper also shows how to obtain continuous-time parameters that are consistent with discrete-time econometric estimates. The continuous-time solution is the limit of that of Campbell and Viceira and has the property that conservative long-term investors have a large positive intertemporal hedging demand for stocks.
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John Y. Campbell Harvard University - Department of Economics George Chacko Harvard Business School Jorge F. Rodriguez Merrill Lynch Luis M. Viceira Harvard Business School - Finance Unit
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08 Mar 03
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12 Jan 04
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This note derives an approximate solution to a continuous-time intertemporal portfolio and consumption choice problem. The problem is the continuous-time equivalent of the discrete-time problem studied by Campbell and Viceira (1999), in which the expected excess return on a risky asset follows an AR(1)process, while the riskless interest rate is constant. The note also shows how to obtain continuous-time parameters that are consistent with discrete-time econometric estimates. The continuous-time solution is numerically close to that of Campbell and Viceira and has the property that conservative long-term investors have a large positive intertemporal hedging demand for stocks.
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John Y. Campbell Harvard University - Department of Economics George Chacko Harvard Business School Jorge F. Rodriguez Merrill Lynch Luis M. Viceira Harvard Business School - Finance Unit
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24 Oct 02
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27 Oct 09
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648
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Abstract:
This note derives an approximate solution to a continuous-time intertemporal portfolio and consumption choice problem. The problem is the continuous-time equivalent of the discrete-time problem studied by Campbell and Viceira (1999), in which the expected excess return on a risky asset follows an AR(1) process, while the riskless interest rate is constant. The note also shows how to obtain continuous-time parameters that are consistent with discrete-time econometric estimates. The continuous-time solution is numerically close to that of Campbell and Viceira and has the property that conservative long-term investors have a large positive intertemporal hedging demand for stocks.
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13.
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Understanding Inflation-Indexed Bond Markets
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation Luis M. Viceira Harvard Business School - Finance Unit
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Posted:
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22 May 09
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Last Revised:
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27 May 09
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685 ( 9,072) |
3
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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22 May 09
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Last Revised:
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22 May 09
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515
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3
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Abstract:
This paper explores the history of inflation-indexed bond markets in the US and the UK. It documents a massive decline in long-term real interest rates from the 1990's until 2008, followed by a sudden spike in these rates during the
financial crisis of 2008. Break even inflation rates, calculated from inflation-indexed and nominal government bond yields, stabilized until the fall of 2008, when they showed dramatic declines. The paper asks to what extent short-term real interest rates, bond risks, and liquidity explain the trends before 2008 and the unusual developments in the fall of 2008. Low inflation-indexed yields and high short-term volatility of inflation-indexed bond returns do not invalidate the basic case for these bonds, that they provide a safe asset for long-term investors. Governments should expect inflation-indexed bonds to be a relatively cheap form of debt
financing going forward, even though they have offered high returns over the past decade.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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27 May 09
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Last Revised:
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27 May 09
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170
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3
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Abstract:
This paper explores the history of inflation-indexed bond markets in the US and the UK. It documents a massive decline in long-term real interest rates from the 1990's until 2008, followed by a sudden spike in these rates during the financial crisis of 2008. Breakeven inflation rates, calculated from inflation-indexed and nominal government bond yields, stabilized until the fall of 2008, when they showed dramatic declines. The paper asks to what extent short-term real interest rates, bond risks, and liquidity explain the trends before 2008 and the unusual developments in the fall of 2008. Low inflation-indexed yields and high short-term volatility of inflation-indexed bond returns do not invalidate the basic case for these bonds, that they provide a safe asset for long-term investors. Governments should expect inflation-indexed bonds to be a relatively cheap form of debt financing going forward, even though they have offered high returns over the past decade.
Expectations hypothesis, Liquidity, Term premia, TIPS
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14.
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Investing Retirement Wealth: A Life-Cycle Model
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School Francisco J. Gomes London Business School Pascal J. Maenhout INSEAD - Finance
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Posted:
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20 Apr 99
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Last Revised:
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18 Nov 08
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608 ( 10,761) |
53
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School Francisco J. Gomes London Business School Pascal J. Maenhout INSEAD - Finance
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15 Aug 00
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Last Revised:
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18 Nov 08
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582
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53
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Abstract:
If household portfolios are constrained by borrowing and short-sales restrictions, or by fixed costs of participating in risky asset markets, then alternative retirement savings systems may affect household welfare by relaxing these constraints. This paper uses a calibrated partial-equilibrium model of optimal life-cycle portfolio choice to explore the empirical relevance of these issues. In a benchmark case, we find ex-ante welfare gains equivalent to a 3.7% increase in consumption from the investment of half of retirement wealth in the equity market. The main channel through which these gains are realized is that the higher average return on equities permits a lower Social Security tax rate on younger households, which helps households smooth their consumption over the life cycle. There is a smaller welfare gain of 0.5% of consumption when Social Security tax rates are held constant. We also find that realistic heterogeneity of risk aversion and labor income risk can strongly affect optimal portfolio choice over the life cycle, which provides one argument for a privatized Social Security system with an element of personal portfolio choice.
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School Francisco J. Gomes London Business School Pascal J. Maenhout INSEAD - Finance
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| Posted: |
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20 Apr 99
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Last Revised:
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08 May 00
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26
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53
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Abstract:
If household portfolios are constrained by borrowing and short-sales restrictions asset markets, then alternative retirement savings systems may affect household welfare by relaxing these constraints. This paper uses a calibrated partial-equilibrium model of optimal life-cycle portfolio choice to explore the empirical relevance of these issues. In a benchmark case, we find ex-ante welfare gains equivalent to a 3.7% increase in consumption from the investment of half of retirement wealth in the equity market. The main channel through which these gains are realized is that the higher average return on equities permits a lower Social Security tax rate on younger households, which helps households smooth their consumption over the life cycle. There is a smaller welfare gain of 0.5% of consumption when Social Security tax rates are held constant. We also find that realistic heterogeneity of risk aversion and labor income risk can strongly affect optimal portfolio choice over the life cycle, which provides one argument for a privatized Social Security system with an element of personal portfolio choice.
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15.
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Predicting the Equity Premium Out of Sample: Can Anything Beat the Historical Average?
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John Y. Campbell Harvard University - Department of Economics Samuel Brodsky Thompson Arrowstreet Capital, L.P.
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Posted:
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28 Jul 05
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Last Revised:
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23 Jul 09
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606 ( 10,819) |
52
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John Y. Campbell Harvard University - Department of Economics Samuel Brodsky Thompson Arrowstreet Capital, L.P.
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28 Jul 05
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Last Revised:
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09 Aug 05
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547
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52
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Abstract:
A number of variables are correlated with subsequent returns on the aggregate US stock market in the 20th Century. Some of these variables are stock market valuation ratios, others reflect patterns in corporate finance or the levels of short and long-term interest rates. Amit Goyal and Ivo Welch (2004) have argued that in-sample correlations conceal a systematic failure of these variables out of sample: None are able to beat a simple forecast based on the historical average stock return. In this note we show that forecasting variables with significant forecasting power in-sample generally have a better out-of-sample performance than a forecast based on the historical average return, once sensible restrictions are imposed on the signs of coefficients and return forecasts. The out-of-sample predictive power is small, but we find that it is economically meaningful. We also show that a variable is quite likely to have poor out-of-sample performance for an extended period of time even when the variable genuinely predicts returns with a stable coefficient.
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John Y. Campbell Harvard University - Department of Economics Samuel Brodsky Thompson Arrowstreet Capital, L.P.
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09 Aug 05
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Last Revised:
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23 Jul 09
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59
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52
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Abstract:
A number of variables are correlated with subsequent returns on the aggregate US stock market in the 20th Century. Some of these variables are stock market valuation ratios, others reflect patterns in corporate finance or the levels of short- and long-term interest rates. Amit Goyal and Ivo Welch (2004) have argued that in-sample correlations conceal a systematic failure of these variables out of sample: None are able to beat a simple forecast based on the historical average stock return. In this note we show that forecasting variables with significant forecasting power in-sample generally have a better out-of-sample performance than a forecast based on the historical average return, once sensible restrictions are imposed on thesigns of coefficients and return forecasts. The out-of-sample predictive power is small, but we find that it is economically meaningful. We also show that a variable is quite likely to have poor out-of-sample performance for an extended period of time even when the variable genuinely predicts returns with a stable coefficient.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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16.
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Foreign Currency for Long-Term Investors
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit Joshua S. White University of Illinois at Urbana-Champaign - Department of Finance
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Posted:
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20 Jul 02
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Last Revised:
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18 Nov 08
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589 ( 11,264) |
7
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit Joshua S. White University of Illinois at Urbana-Champaign - Department of Finance
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04 Sep 02
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04 Sep 02
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26
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Abstract:
Conventional wisdom holds that conservative investors should avoid exposure to foreign currency risk. Even if they hold foreign equities, they should hedge the currency exposure of these positions and should hold only domestic Treasury bills. This Paper argues that the conventional wisdom may be wrong for long-term investors. Domestic bills are risky for long-term investors because real interest rates vary over time, and bills must be rolled over at uncertain future interest rates. This risk can be hedged by holding foreign currency if the domestic currency tends to depreciate when the domestic real interest rate falls, as implied by the theory of uncovered interest parity. Empirically this effect is important and can lead conservative long-term investors to hold more than half their wealth in foreign currency.
Home bias, portfolio choice, foreign exchange rates, intertemporal hedging demand, uncovered interest parity
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit Joshua S. White University of Illinois at Urbana-Champaign - Department of Finance
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| Posted: |
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05 Aug 02
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Last Revised:
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18 Nov 08
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528
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7
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Abstract:
Conventional wisdom holds that conservative investors should avoid exposure to foreign currency risk. Even if they hold foreign equities, they should hedge the currency exposure of these positions and should hold only domestic Treasury bills. This paper argues that the conventional wisdom may be wrong for long-term investors. Domestic bills are risky for long-term investors because real interest rates vary over time, and bills must be rolled over at uncertain future interest rates. This risk can be hedged by holding foreign currency if the domestic currency tends to depreciate when the domestic real interest rate falls, as implied by the theory of uncovered interest parity. Empirically, this effect is important and can lead conservative long-term investors to hold more than half their wealth in foreign currency.
Foreign Exchange Rates, Home Bias, Intertemporal Hedging Demand, Portfolio Choice, Uncovered Interest Parity
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit Joshua S. White University of Illinois at Urbana-Champaign - Department of Finance
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| Posted: |
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20 Jul 02
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Last Revised:
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25 Jul 02
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35
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7
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Abstract:
Conventional wisdom holds that conservative investors should avoid exposure to foreign currency risk. Even if they hold foreign equities, they should hedge the currency exposure of these positions and should hold only domestic Treasury bills. This paper argues that the conventional wisdom may be wrong for long-term investors. Domestic bills are risky for long-term investors, because real interest rates vary over time and bills must be rolled over at uncertain future interest rates. This risk can be hedged by holding foreign currency if the domestic currency tends to depreciate when the domestic real interest rate falls, as implied by the theory of uncovered interest parity. Empirically this effect is important and can lead conservative long-term investors to hold more than half their wealth in foreign currency.
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17.
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Global Currency Hedging
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John Y. Campbell Harvard University - Department of Economics Karine Serfaty-de Medeiros OC&C Strategy Consultants Luis M. Viceira Harvard Business School - Finance Unit
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Posted:
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20 Mar 07
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Last Revised:
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29 Jan 09
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509 ( 13,899) |
13
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John Y. Campbell Harvard University - Department of Economics Karine Serfaty-de Medeiros OC&C Strategy Consultants Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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27 Jun 07
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Last Revised:
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07 Aug 07
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43
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13
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Abstract:
Over the period 1975 to 2005, the US dollar (particularly in relation to the Canadian dollar) and the euro and Swiss franc (particularly in the second half of the period) have moved against world equity markets. Thus these currencies should be attractive to risk-minimizing global equity investors despite their low average returns. The risk-minimizing currency strategy for a global bond investor is close to a full currency hedge, with a modest long position in the US dollar. There is little evidence that risk-minimizing investors should adjust their currency positions in response to movements in interest differentials.
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John Y. Campbell Harvard University - Department of Economics Karine Serfaty-de Medeiros OC&C Strategy Consultants Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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20 Mar 07
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Last Revised:
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29 Jan 09
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466
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13
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Abstract:
Over the period 1975 to 2005, the US dollar (particularly in relation to the Canadian dollar) and the euro and Swiss franc (particularly in the second half of the period) have moved against world equity markets. Thus these currencies should be attractive to risk-minimizing global equity investors despite their low average returns. The risk-minimizing currency strategy for a global bond investor is close to a full currency hedge, with a modest long position in the US dollar. There is little evidence that risk-minimizing investors should adjust their currency positions in response to movements in interest differentials.
Foreign exchange, Siegel's paradox, risk management
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18.
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John Y. Campbell Harvard University - Department of Economics Tarun Ramadorai University of Oxford - Said Business School Tuomo Vuolteenaho Arrowstreet Capital, LP
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| Posted: |
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25 Mar 04
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Last Revised:
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12 Nov 04
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501 (14,199)
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7
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Abstract:
Many questions about institutional trading can only be answered if one can track institutional equity ownership continuously. However, these data are only available on quarterly reporting dates. We infer institutional trading behavior from the tape, the Transactions and Quotes database of the New York Stock Exchange, by regressing quarterly changes in reported institutional ownership on quarterly buy and sell volume in different trade size categories. Our regression method predicts institutional ownership signifcantly better than the simple cutoff rules used in previous research. We also find that total buy (sell) volume predicts increasing (decreasing) institutional ownership, consistent with institutions demanding liquidity in aggregate. Furthermore,institutions tend to trade in large or very small sizes: buy (sell) volume at these sizes predicts increasing (decreasing) institutional ownership, while the pattern reverses at intermediate trade sizes that appear favored by individuals. We then explore changes in institutional trading strategies. Institutions appear to prefer medium size trades on high volume days and large size trades on high volatility days.
institutions, individuals, trading behavior, execution
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19.
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Household Risk Management and Optimal Mortgage Choice
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School
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Posted:
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20 Feb 02
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Last Revised:
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18 Nov 08
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495 ( 14,451) |
71
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School
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| Posted: |
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08 Jun 03
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Last Revised:
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08 Jun 03
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44
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71
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Abstract:
A typical household has a home mortgage as its most significant financial contract. The form of this contract is correspondingly important. This paper studies the choice between a fixed-rate (FRM) and an adjustable-rate (ARM) mortgage. In an environment with uncertain inflation, a nominal FRM has risky real capital value whereas an ARM has a stable real capital value. However an ARM can increase the short-term variability of required real interest payments. This is a disadvantage of the ARM for a household that faces borrowing constraints and has only a small buffer stock of financial assets. The paper uses numerical methods to solve a life-cycle model with risky labor income and borrowing constraints, under alternative assumptions about available mortgage contracts. While an ARM is generally an attractive form of mortgage, a household with a large mortgage, risky labor income, high risk aversion, a high cost of default, and a low probability of moving is less likely to prefer an ARM. The paper also considers an inflation-indexed FRM, which removes the wealth risk of the nominal FRM without incurring the income risk of the ARM, and is therefore a superior vehicle for household risk management. The welfare gain from mortgage indexation can be very large.
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School
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| Posted: |
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20 Feb 02
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Last Revised:
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18 Nov 08
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451
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71
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Abstract:
Home mortgages are the most significant financial contract for many households. The form of this contract is correspondingly important. This paper studies the choice between fixed-rate (FRM) and adjustable-rate (ARM) mortgages. In an environment with uncertain inflation, nominal FRMs have risky real capital value whereas ARMs have safe capital value. However ARMs can greatly increase the short-term variability of required real interest payments. This is a serious disadvantage of ARMs for households who face borrowing constraints and have only a small buffer stock of financial assets. The paper uses numerical methods to solve a life-cycle model with risky labor income and borrowing constraints, under alternative assumptions about available mortgage contracts. Households with large mortgages, risky labor income, high risk aversion, and a low probability of moving are more likely to prefer nominal FRMs. The paper also considers inflation-indexed FRMs. These mortgages remove the wealth risk of nominal FRMs without incurring the income risk of ARMs, and therefore are a superior vehicle for household risk management. The paper finds that the welfare gains of mortgage indexation can be very large.
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20.
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How do House Prices Affect Consumption? Evidence from Micro Data
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School
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Posted:
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02 Feb 05
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Last Revised:
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18 Nov 08
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463 ( 15,829) |
50
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School
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| Posted: |
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19 Sep 05
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Last Revised:
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19 Sep 05
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44
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50
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Abstract:
Housing is a major component of wealth. Since house prices fluctuate considerably over time, it is important to understand how these fluctuations affect households' consumption decisions. Rising house prices may stimulate consumption by increasing households' perceived wealth, or by relaxing borrowing constraints. This paper investigates the response of household consumption to house prices using UK micro data. We estimate the largest effect of house prices on consumption for older homeowners, and the smallest effect, insignificantly different from zero, for younger renters. This finding is consistent with heterogeneity in the wealth effect across these groups. In addition, we find that regional house prices affect regional consumption growth. Predictable changes in house prices are correlated with predictable changes in consumption, particularly for households that are more likely to be borrowing constrained, but this effect is driven by national rather than regional house prices and is important for renters as well as homeowners, suggesting that UK house prices are correlated with aggregate financial market conditions.
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John Y. Campbell Harvard University - Department of Economics Joao F. Cocco London Business School
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| Posted: |
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02 Feb 05
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Last Revised:
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18 Nov 08
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419
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50
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Abstract:
Housing is a major component of wealth. Since house prices fluctuate considerably over time, it is important to understand how these fluctuations affect households' consumption decisions. Rising house prices may stimulate consumption by increasing households' perceived wealth, or by relaxing borrowing constraints. This paper investigates the response of household consumption to house prices using UK micro data. We estimate the largest effect of house prices on consumption for older homeowners, and the smallest effect, insignificantly different from zero, for younger renters. This finding is consistent with heterogeneity in the wealth effect across these groups. It suggests that as the population ages and becomes more concentrated in the old homeowners group, aggregate consumption may become more responsive to house prices. In addition, we find that regional house prices affect regional consumption growth. Predictable changes in house prices are correlated with predictable changes in consumption, particularly for households that are more likely to be borrowing constrained, but this effect is driven by national rather than regional house prices and is important for renters as well as homeowners, suggesting that UK house prices are correlated with aggregate financial market conditions.
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21.
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Laurent E. Calvet HEC School of Management - Department of Finance and Economics John Y. Campbell Harvard University - Department of Economics Paolo Sodini Stockholm School of Economics - Department of Finance
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| Posted: |
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21 Mar 07
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Last Revised:
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21 Mar 07
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443 (16,794)
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14
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Abstract:
This paper investigates the dynamics of individual portfolios in a unique dataset containing the disaggregated wealth and income of all households in Sweden. Between 1999 and 2002, stockmarket participation slightly increased but the average share of risky assets in the financial portfolio of participants fell moderately, implying little aggregate rebalancing in response to the decline in risky asset prices during this period. We show that these aggregate results conceal strong household-level evidence of active rebalancing, which on average offsets about one half of idiosyncratic passive variations in the risky asset share. Sophisticated households with greater education, wealth, and income, and holding better diversified portfolios, tend to rebalance more aggressively. We also study the decisions to enter and exit risky financial markets. More sophisticated households are more likely to enter, and less likely to exit. Portfolio characteristics and performance also influence exit decisions. Households with poorly diversified portfolios and poor returns on their mutual funds are more likely to exit; however, consistent with the literature on the disposition effect, households with poor returns on their directly held stocks are less likely to exit.
Asset allocation, disposition effect, diversification, participation, portfolio rebalancing
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22.
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John Y. Campbell Harvard University - Department of Economics Adi Sunderam Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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20 Mar 08
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Last Revised:
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29 Jan 09
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401 (19,180)
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15
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Abstract:
The covariance between US Treasury bond returns and stock returns has moved considerably over time. While it was slightly positive on average in the period 1953 - 2005, it was particularly high in the early 1980's and negative in the early 2000's. This paper specifies and estimates a model in which the nominal term structure of interest rates is driven by five state variables: the real interest rate, risk aversion, temporary and permanent components of expected inflation, and the covariance between nominal variables and the real economy. The last of these state variables enables the model to fit the changing covariance of bond and stock returns. Log nominal bond yields and term premia are quadratic in these state variables, with term premia determined mainly by the product of risk aversion and the nominal-real covariance. The concavity of the yield curve - the level of intermediate-term bond yields, relative to the average of short- and long-term bond yields - is a good proxy for the level of term premia. The nominal-real covariance has declined since the early 1980's, driving down term premia.
Term structure of interest rates, inflation risk, time varying expected returns, bond return predictability, expectations hypothesis, macro asset pricing
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23.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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| Posted: |
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08 Apr 01
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Last Revised:
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08 Apr 01
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341 (23,455)
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110
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Abstract:
The use of price earnings ratios and dividend-price ratios as forecasting variables for the stock market is examined using aggregate annual US data 1871 to 2000 and aggregate quarterly data for twelve countries since 1970. Various simple efficient-markets models of financial markets imply that these ratios should be useful in forecasting future dividend growth, future earnings growth, or future productivity growth. We conclude that, overall, the ratios do poorly in forecasting any of these. Rather, the ratios appear to be useful primarily in forecasting future stock price changes, contrary to the simple efficient-markets models. This paper is an update of our earlier paper (1998), to take account of the remarkable behavior of the stock market in the closing years of the twentieth century.
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24.
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John Y. Campbell Harvard University - Department of Economics Karine Serfaty-de Medeiros OC&C Strategy Consultants Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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29 Jan 09
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Last Revised:
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29 Jan 09
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290 (28,423)
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13
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Abstract:
Over the period 1975 to 2005, the US dollar (particularly in relation to the Canadian dollar) and the euro and Swiss franc (particularly in the second half of the period) have moved against world equity markets. Thus these currencies should be attractive to risk-minimizing global equity investors despite their low average returns. The risk-minimizing currency strategy for a global bond investor is close to a full currency hedge, with a modest long position in the US dollar. There is little evidence that risk-minimizing investors should adjust their currency positions in response to movements in interest differentials.
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25.
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John Y. Campbell Harvard University - Department of Economics Tarun Ramadorai University of Oxford - Said Business School Allie Schwartz Harvard University
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| Posted: |
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05 Jul 07
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Last Revised:
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05 Jul 07
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254 (33,036)
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10
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Abstract:
Many questions about institutional trading can only be answered if one can track high-frequency changes in institutional ownership. In the U.S., however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behavior from the tape, the Transactions and Quotes database of the New York Stock Exchange, using a sophisticated method that best matches quarterly 13-F data. We find that daily institutional trades are highly persistent and respond positively to recent daily returns but negatively to longer-term past daily returns. Institutional trades, particularly sells, appear to generate short-term losses - possibly reflecting institutional demand for liquidity - but longer-term profits. One source of these profits is that institutions anticipate both earnings surprises and post-earnings-announcement drift. These results are different from those obtained using a standard size cutoff rule for institutional trades.
institutions, trading, liquidity, earnings announcements, post-earnings-announcement-drift.
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26.
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John Y. Campbell Harvard University - Department of Economics Tarun Ramadorai University of Oxford - Said Business School Tuomo Vuolteenaho Arrowstreet Capital, LP
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| Posted: |
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28 Jul 05
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Last Revised:
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29 Jul 05
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216 (39,503)
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11
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Abstract:
Many questions about institutional trading can only be answered if one can track high-frequency changes in institutional ownership. In the US, however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behavior from the "tape", the Transactions and Quotes database of the New York Stock Exchange, using both a naive approach and a sophisticated method that best matches quarterly 13-F data. Increases in our measures of institutional flows negatively predict returns, particularly when institutions are selling. We interpret this as evidence that 13-F institutions compensate more patient investors for the service of providing liquidity. We also find that both very large and very small trades signal institutional activity, while medium size trades signal activity by the rest of the market.
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27.
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Down or Out: Assessing the Welfare Costs of Household Investment Mistakes
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Laurent E. Calvet HEC School of Management - Department of Finance and Economics John Y. Campbell Harvard University - Department of Economics Paolo Sodini Stockholm School of Economics - Department of Finance
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Posted:
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11 Feb 06
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02 Jul 09
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195 ( 43,605) |
63
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Laurent E. Calvet HEC School of Management - Department of Finance and Economics John Y. Campbell Harvard University - Department of Economics Paolo Sodini Stockholm School of Economics - Department of Finance
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11 Feb 06
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02 Jul 09
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32
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Abstract:
This paper investigates the efficiency of household investment decisions in a unique dataset containing the disaggregated wealth and income of the entire population of Sweden. The analysis focuses on two main sources of inefficiency in the financial portfolio: underdiversification of risky assets ("down") and nonparticipation in risky asset markets ("out"). We find that while a few households are very poorly diversified, the cost of diversification mistakes is quite modest for most of the population. For instance, a majority of participating Swedish households are sufficiently diversified internationally to outperform the Sharpe ratio of their domestic stock market. We document that households with greater financial sophistication tend to invest more efficiently but also more aggressively, so the welfare cost of portfolio inefficiency tends to be greater for these households. The welfare cost of nonparticipation is smaller by almost one half when we take account of the fact that nonparticipants would be unlikely to invest efficiently if they participated in risky asset markets.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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Laurent E. Calvet HEC School of Management - Department of Finance and Economics John Y. Campbell Harvard University - Department of Economics Paolo Sodini Stockholm School of Economics - Department of Finance
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21 Feb 06
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Last Revised:
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18 May 07
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163
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63
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Abstract:
This paper investigates the efficiency of household investment decisions in a unique dataset containing the disaggregated wealth and income of the entire population of Sweden. The analysis focuses on two main sources of inefficiency in the financial portfolio: underdiversification of risky assets ("down") and nonparticipation in risky asset markets ("out"). We find that while a few households are very poorly diversified, the cost of diversification mistakes is quite modest for most of the population. For instance, a majority of participating Swedish households are sufficiently diversified internationally to outperform the Sharpe ratio of their domestic stock market. We document that households with greater financial sophistication tend to invest more efficiently but also more aggressively, so the welfare cost of portfolio inefficiency tends to be greater for these households. The welfare cost of nonparticipation is smaller by almost one half when we take account of the fact that nonparticipants would be unlikely to invest efficiently if they participated in risky asset markets.
Asset allocation, diversification, familiarity, participation
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28.
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John Y. Campbell Harvard University - Department of Economics Sanford J. Grossman University of Pennsylvania - Finance Department Jiang Wang Massachusetts Institute of Technology (MIT) - Sloan School of Management
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30 Jan 03
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30 Jan 03
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160 (53,058)
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182
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Abstract:
This paper investigates the relationship between stock market trading volume and the autocorrelations of daily stock index returns. The paper finds that stock return autocorrelations tend to decline with trading volume. The paper explains this phenomenon using a model in which risk-averse "market makers" accommodate buying or selling pressure from "liquidity" or "non-informational" traders. Changing expected stock returns reward market makers for playing this role. The model implies that a stock price decline on a high-volume day is more likely than a stock price decline on a low-volume day to be associated with an increase in the expected stock return.
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29.
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John Y. Campbell Harvard University - Department of Economics
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04 Jul 04
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27 Sep 08
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150 (56,377)
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320
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Abstract:
No abstract is available for this paper.
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30.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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07 Jul 04
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16 Apr 08
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141 (59,633)
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406
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Abstract:
A linearization of a rational expectations present value model for corporate stock prices produces a simple relation between the log dividend-price ratio and mathematical expectations of future log real dividend changes and future real discount rates. This relation can be tested using vector autoregressive methods. Three versions of the linearized model, differing in the measure of discount rates, are tested for U.S. time series 1871-1986: versions using real interest rate data, aggregate real consumption data, and return variance data. The results yield a metric to judge the relative importance of real dividend growth, measured real discount rates and unexplained factors in determining the dividend-price ratio.
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31.
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John Y. Campbell Harvard University - Department of Economics N. Gregory Mankiw Harvard University - Department of Economics
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25 Oct 00
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25 Oct 00
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140 (60,000)
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161
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Abstract:
This paper proposes that the time-series data on consumption, income, and interest rates are best viewed as generated not by a single representative consumer but by two groups of consumers. Half the consumers are forward-looking and consume their permanent income, but are extremely reluctant to substitute consumption intertemporally. Half the consumers follow the "rule of thumb" of consuming their current income. The paper documents three empirical regularities that, it argues, are best explained by this model. First, expected changes in income are associated with expected changes in consumption. Second, expected real interest rates are not associated with expected changes in consumption. Third, periods in which consumption is high relative to income are typically followed by high growth in income. The paper concludes by briefly discussing the implications of these findings for economic policy and economic research.
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32.
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John Y. Campbell Harvard University - Department of Economics
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11 Nov 00
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11 Nov 00
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129 (64,363)
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254
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Abstract:
This paper shows that unexpected stock returns must be associated with changes in expected future dividends or expected future returns. A vector autoregressive method is used to break unexpected stock returns into these two components. In U.S. monthly data in 1927-88, one-third of the variance of unexpected returns is attributed to the variance of changing expected dividends, one-third to the variance of changing expected returns, and one-third to the covariance of the two components. Changing expected returns have a large effect on stock prices because they are persistent: a 1% innovation in the expected return is associated with a 4 or 5% capital loss. Changes in expected returns are negatively correlated with changes in expected dividends, increasing the stock market reaction to dividend news. In the period 1952-88, changing expected returns account for a larger fraction of stock return variation than they do in the period 1927-51.
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33.
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Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk
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John Y. Campbell Harvard University - Department of Economics Martin Lettau Haas School of Business Burton G. G. Malkiel Princeton University - Bendheim Center for Finance Yexiao Xu University of Texas at Dallas - School of Management
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Posted:
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11 Jul 00
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30 Apr 08
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125 ( 66,089) |
334
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John Y. Campbell Harvard University - Department of Economics Martin Lettau Haas School of Business Burton G. G. Malkiel Princeton University - Bendheim Center for Finance Yexiao Xu University of Texas at Dallas - School of Management
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24 Aug 00
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30 Apr 08
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0
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This paper uses a disaggregated approach to study the volatility of common stocks at the market, industry, and firm levels. Over the period 1962-97 there has been a noticeable increase in firm-level volatility relative to market volatility. Accordingly, correlations among individual stocks and the explanatory power of the market model for a typical stock have declined, while the number of stocks needed to achieve a given level of diversification has increased. All the volatility measures move together countercyclically and help to predict GDP growth. Market volatility tends to lead the other volatility series. Factors that may be responsible for these findings are suggested.
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John Y. Campbell Harvard University - Department of Economics Martin Lettau Haas School of Business Burton G. G. Malkiel Princeton University - Bendheim Center for Finance Yexiao Xu University of Texas at Dallas - School of Management
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11 Jul 00
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01 Feb 01
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125
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334
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Abstract:
This paper uses a disaggregated approach to study the volatility of common stocks at the market, industry, and firm levels. Over the period 1962-97 there has been a noticeable increase in firm-level volatility relative to market volatility. Accordingly correlations among individual stocks and the explanatory power of the market model for a typical stock have declined, while the number of stocks needed to achieve a given level of diversification has increased. All the volatility measures move together countercyclically and help to predict GDP growth. Market volatility tends to lead the other volatility series. Factors that may be responsible for these findings are suggested.
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34.
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Elasticities of Substitution in Real Business Cycle Models with Home Production
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John Y. Campbell Harvard University - Department of Economics Sydney C. Ludvigson New York University - Department of Economics
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Posted:
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04 Feb 99
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26 Nov 03
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119 ( 68,819) |
7
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John Y. Campbell Harvard University - Department of Economics Sydney C. Ludvigson New York University - Department of Economics
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26 Aug 00
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26 Aug 00
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12
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This paper constructs a simple model of home production that demonstrates the connection between the intertemporal elasticity of substitution in market consumption (IES) and the static elasticity of substitution between home and market consumption (SES), when the utility function is additively separable over home and market consumption. Understanding this connection is important because there is a large body of empirical evidence suggesting that the IES is small, but little evidence on the size of the SES. We use our framework to shed light on the properties of a home production model with a low IES. We find that such a model must have two fundamental properties in order to match key aspects of the U.S. aggregate data. First, the steady-state growth rate of technology must be the same across sectors. Second, shocks to technology must be sufficiently positively correlated across sectors.
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John Y. Campbell Harvard University - Department of Economics Sydney C. Ludvigson New York University - Department of Economics
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04 Feb 99
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Last Revised:
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26 Nov 03
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107
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7
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Abstract:
This paper constructs a simple model of home production that demonstrates the connection between the intertemporal elasticity of substitution in market consumption (IES) and the static elasticity of substitution between home and market consumption (SES), when the utility function is additively separable over home and market consumption. Understanding this connection is important because there is a large body of empirical evidence suggesting that the IES is small, but little evidence on the size of the SES. We use our framework to shed light on the properties of a home production model with a low IES. We find that such a model must have two fundamental properties in order to match key aspects of the U.S. aggregate data. First, the steady-state growth rate of technology must be the same across sectors. Second, shocks to technology must be sufficiently positively correlated across sectors.
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35.
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The Term Structure of the Risk-Return Tradeoff
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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Posted:
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09 Mar 05
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Last Revised:
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10 Aug 09
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111 ( 72,822) |
28
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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14 Jun 05
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23 Jun 05
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30
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28
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Abstract:
Recent research in empirical finance has documented that expected excess returns on bonds and stocks, real interest rates, and risk shift over time in predictable ways. Furthermore, these shifts tend to persist over long periods of time. In this paper, we propose an empirical model that is able to capture these complex dynamics, yet is simple to apply in practice, and we explore its implications for asset allocation. Changes in investment opportunities can alter the risk-return tradeoff of bonds, stocks, and cash across investment horizons, thus creating a 'term structure of the risk-return tradeoff'. We show how to extract this term structure from our parsimonious model of return dynamics, and illustrate our approach using data from the US stock and bond markets. We find that asset return predictability has important effects on the variance and correlation structure of returns on stocks, bonds and T-bills across investment horizons.
Risk-return tradeoff, mean-variance analysis, long-horizon investing, vector autoregression
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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09 Mar 05
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Last Revised:
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10 Aug 09
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81
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28
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Abstract:
Recent research in empirical finance has documented that expected excess returns on bonds and stocks, real interest rates, and risk shift over time in predictable ways. Furthermore, these shifts tend to persist over long periods of time. In this paper we propose an empirical model that is able to capture these complex dynamics, yet is simple to apply in practice, and we explore its implications for asset allocation. Changes in investment opportunities can alter the risk-return tradeoff of bonds, stocks, and cash across investment horizons, thus creating a ``term structure of the risk-return tradeoff.'' We show how to extract this term structure from our parsimonious model of return dynamics, and illustrate our approach using data from the U.S. stock and bond markets. We find that asset return predictability has important effects on the variance and correlation structure of returns on stocks, bonds and T-bills across investment horizons.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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36.
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A Multivariate Model of Strategic Asset Allocation
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John Y. Campbell Harvard University - Department of Economics Yeung Lewis Chan Hong Kong University of Science & Technology (HKUST) - Department of Finance Luis M. Viceira Harvard Business School - Finance Unit
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Posted:
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25 Oct 01
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Last Revised:
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06 Dec 01
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107 ( 74,902) |
130
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John Y. Campbell Harvard University - Department of Economics Yeung Lewis Chan Hong Kong University of Science & Technology (HKUST) - Department of Finance Luis M. Viceira Harvard Business School - Finance Unit
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06 Dec 01
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06 Dec 01
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35
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130
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Abstract:
Much recent work has documented evidence for the predictability of asset returns. We show how such predictability can affect the portfolio choices of long-lived investors who value wealth not for its own sake but for the consumption their wealth can support. We develop an approximate solution method for the optimal consumption and portfolio choice problem of an infinitely-lived investor with Epstein-Zin utility who faces a set of asset returns described by a vector autoregression in returns and state variables. Empirical estimates in long-run annual and postwar quarterly US data suggest that the predictability of stock returns greatly increases the optimal demand for stocks. The role of nominal bonds in long-term portfolios depends on the importance of real interest rate risk relative to other sources of risk. We extend the analysis to consider long-term inflation-indexed bonds and find that these bonds greatly increase the utility of conservative investors, who should hold large positions when they are available.
Intertemporal hedging demand, portfolio choice, predictability, strategic asset allocation
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John Y. Campbell Harvard University - Department of Economics Yeung Lewis Chan Hong Kong University of Science & Technology (HKUST) - Department of Finance Luis M. Viceira Harvard Business School - Finance Unit
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25 Oct 01
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Last Revised:
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25 Oct 01
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72
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130
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Abstract:
Much recent work has documented evidence for predictability of asset returns. We show how such predictability can affect the portfolio choices of long-lived investors who value wealth not for its own sake but for the consumption their wealth can support. We develop an approximate solution method for the optimal consumption and portfolio choice problem of an infinitely-lived investor with Epstein-Zin utility who faces a set of asset returns described by a vector autoregression in returns and state variables. Empirical estimates in long-run annual and postwar quarterly US data suggest that the predictability of stock returns greatly increases the optimal demand for stocks. The role of nominal bonds in long-term portfolios depends on the importance of real interest rate risk relative to other sources of risk. We extend the analysis to consider long-term inflation-indexed bonds and find that these bonds greatly increase the utility of conservative investors, who should hold large positions when they are available.
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37.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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14 Jan 01
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Last Revised:
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14 Jan 01
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98 (79,875)
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279
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Abstract:
This paper presents estimates indicating that, for aggregate U.S. stock market data 1871-1986, a long historical average of real earnings is a good predictor of the present value of future real dividends. This is true even when the information contained in stock prices is taken into account. We estimate that for each year the optimal forecast of the present value of future real dividends is roughly a weighted average of moving average earnings and current real price, with between 2/3 and 3/4 of the weight on the earnings measure. This means that simple present value models of stock market prices can be strongly rejected. We use a vector autoregressive approach which enables us to compute the implications of this for the behavior of stock prices and returns. We estimate that log dividend-price ratios are more variable than, and virtually uncorrelated with, their theoretical counterparts given the present value models. Annual returns on stocks are quite highly correlated with their theoretical counterparts, but are two to four times as variable. Our approach also reveals the connection between recent papers showing forecastability of long-horizon returns on corporate stocks, and earlier literature claiming that stock prices are too volatile to be accounted for in terms of simple present value models. We show that excess volatility directly implies the forecastability of long-horizon returns.
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38.
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John Y. Campbell Harvard University - Department of Economics John Matthew Ammer U.S. Federal Reserve Board of Governors
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05 Jul 04
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Last Revised:
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15 Sep 08
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94 (82,300)
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254
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Abstract:
No abstract is available for this paper.
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39.
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Martin Lettau Haas School of Business John Y. Campbell Harvard University - Department of Economics
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21 Sep 98
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Last Revised:
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05 May 00
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91 (84,205)
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4
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Abstract:
This paper studies three different measures of monthly stock market volatility: the time-series volatility of daily market returns within the month; the cross-sectional volatility or 'dispersion' of daily returns on industry portfolios, relative to the market, within the month; and the dispersion of daily returns on individual firms, relative to their industries, within the month. Over the period 1962-97 there has been a noticeable increase in firm-level volatility relative to market volatility. All the volatility measures move together in a countercyclical fashion. While market volatility tends to lead the other volatility series, industry-level volatility is a particularly important leading indicator for the business cycle.
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40.
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John Y. Campbell Harvard University - Department of Economics
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16 Jul 00
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Last Revised:
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08 Apr 08
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82 (90,307)
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93
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Abstract:
This paper reviews the behavior of financial asset prices in relation to consumption. The paper lists some important stylized facts that characterize US data, and relates them to recent developments in equilibrium asset pricing theory. Data from other countries are examined to see which features of the US experience apply more generally. The paper argues that to make sense of asset market behavior one needs a model in which the market price of risk is high, time-varying, and correlated with the state of the economy. Models that have this feature, including models with habit-formation in utility, heterogeneous investors, and irrational expectations, are discussed. The main focus is on stock returns and short-term real interest rates, but bond returns are also considered.
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41.
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John Y. Campbell Harvard University - Department of Economics
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10 Jul 00
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Last Revised:
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10 Jul 00
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81 (90,999)
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54
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Abstract:
This paper reviews the literature on the relation between short- and long-term interest rates. It summarizes the mixed evidence on the expectations hypothesis of the term structure: when long rates are high relative to short rates, short rates tend to rise as implied by the expectations hypothesis, but long rates tend to fall which is contrary to the expectations hypothesis. The paper discusses the response of the U.S. bond market to shifts in monetary policy in the spring of 1994, and reviews the debate over the optimal maturity structure of the U.S. government debt.
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42.
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John Y. Campbell Harvard University - Department of Economics Pierre Perron Boston University - Department of Economics
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25 Jun 04
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Last Revised:
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25 Jun 04
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78 (93,217)
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143
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Abstract:
This paper is an introduction to unit root econometrics as applied in macroeconomics. The paper first discusses univariate time series analysis, emphasizing the following topics: alternative representations of unit root processes, unit root testing procedures, the power of unit root tests, and the interpretation of unit root econometrics in finite samples. A second part of the paper tackles similar issues in a multivariate context where cointegration is now the central concept. The paper reviews representation, testing, and estimation of multivariate time series models with some unit roots. Two important themes of this paper are first, the importance of correctly specifying deterministic components of the series; and second, the usefulness of unit root tests not as methods to uncover some -true relation" but as practical devices that can be used to impose reasonable restrictions on the data and to suggest what asymptotic distribution theory gives the best approximation to the finite-sample distribution of coefficient estimates and test statistics.
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43.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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27 Apr 00
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Last Revised:
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03 Jan 02
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75 (95,579)
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185
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Abstract:
The expectations theory of the term structure implies that the spread between a longer-term interest rate and a shorter-term interest rate forecasts two subsequent interest rate changes: the change in yield of the longer-term bond over the life of the shorter-term bond, and a weighted average of the changes in shorter-term rates over the life of the longer-term bond. For postwar U.S. data from McCulloch [1987] and just about any combination of maturities between one month and ten years we find that the former relation is not borne out by the data, the latter roughly is. When the yield spread is high the yield on the longer-term bond tends to fall, contrary to the expectations theory; at the same time, the shorter-term interest rate tends to rise, just as the expectations theory requires. We discuss several possible interpretations of these findings. We argue that they are consistent with a model in which the spread is a multiple of the value implied by the expectations theory. This model could be generated by time-varying risk premia which are correlated with expected increases in short-term interest rates, or by a failure of rational expectations in our sample period.
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44.
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John Y. Campbell Harvard University - Department of Economics Albert S. Kyle University of Maryland
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04 Jul 04
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02 Dec 08
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71 (98,831)
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47
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Abstract:
This paper derives and estimates an equilibrium model of stock price behavior in which exogenous "noise traders" interact with risk-averse "smart money" investors. The model assumes that changes in exponentially detrended dividends and prices are normally distributed, and that smart money investors have constant absolute risk aversion. In equilibrium, the stock price is the present value of expected dividends, discounted at the riskless interest rate, less a constant risk premium, plus a term which is due to noise trading. The model expresses both stock prices and dividends as sums of unobserved components in continuous time. The model is able to explain the volatility and predictability of U.S. stock returns in the period 1871-1986 in either of two ways. Either the discount rate is 4% or below, and the constant risk premium is large; or the discount rate is 5% or above, and noise trading, correlated with fundamentals, increases the volatility of stock prices. The data are not well able to distinguish between these explanations.
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45.
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Understanding Risk and Return
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John Y. Campbell Harvard University - Department of Economics
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Posted:
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19 Jun 98
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Last Revised:
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14 Aug 07
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68 (101,430) |
230
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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14 Aug 07
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14 Aug 07
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68
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230
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Abstract:
This paper uses an intertemporal equilibrium asset pricing model to interpret the cross-sectional pattern of stock and bond returns. The model relates assets' mean returns to their covariances with the contemporaneous return and news about future returns on the market portfolio. In a departure from standard practice, the market portfolio return is measured using data on both the aggregate stock market and aggregate labor income. The paper finds that aggregate stock market risk is the main factor determining excess stock and bond returns, but that the price of stock market risk does not equal the coefficient of relative risk aversion as would be implied by the static Capital Asset Pricing Model.
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John Y. Campbell Harvard University - Department of Economics
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19 Jun 98
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Last Revised:
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19 Jun 98
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0
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Abstract:
This paper uses an equilibrium multifactor model to interpret the cross-sectional pattern of postwar U.S. stock and bond returns. Priced factors include the return on a stock index, revisions in forecasts of future stock returns (to capture intertemporal hedging effects), and revisions in forecasts of future labor income growth (proxies for the return on human capital). Aggregate stock market risk is the main factor determining excess returns; but in the presence of human capital or stock market mean reversion, the coefficient of relative risk aversion is much higher than the price of stock market risk.
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46.
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John Y. Campbell Harvard University - Department of Economics N. Gregory Mankiw Harvard University - Department of Economics
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25 Jun 04
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Last Revised:
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25 Jun 04
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67 (102,311)
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61
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Abstract:
This paper reexamines the consistency of the permanent income hypothesis with aggregate, post-war, United States data. The permanent income hypothesis is nested within a more general model in which a fraction of income accrues to individuals who consume their current income rather than their permanent income. This fraction is estimated to be 40 or 50 percent, indicating a substantial departure from the permanent income hypothesis. This finding is robust to various statistical problems that have plagued previous work, such as time aggregation, and cannot be easily explained by appealing to changes in the real interest rate or to non-separabilities in the utility function.
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47.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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26 Sep 07
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Last Revised:
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02 Dec 07
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64 (104,984)
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10
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Abstract:
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 not have trends or explosive behavior. This fact can be used to strengthen the evidence for predictability in stock returns. Steady-state valuation models are also useful predictors of stock returns given the high degree of persistence in valuation ratios and the difficulty of estimating free parameters in regression models for stock returns. A steady-state approach suggests that the world geometric average equity premium was almost 4% at the end of March 2007, implying a world arithmetic average equity premium somewhat above 5%. Both valuation ratios and the cross-section of stock prices imply that the equity premium fell considerably in the late 20th Century, but has risen modestly in the early years of the 21st Century.
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48.
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David G. Barr Durham University - Business School John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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13 Sep 00
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29 Mar 08
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62 (106,818)
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31
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Abstract:
This paper estimates expected future real interest rates and inflation rates from observed prices of UK government nominal and index-linked bonds. The estimation method takes account of imperfections in the indexation of UK index-linked bonds. It assumes that expected log returns on all bonds are equal, and that expected real interest rates and inflation follow simple time-series processes whose parameters can be estimated from the cross-section of bond prices. The extracted inflation expectations forecast actual future inflation more accurately than nominal yields do. The estimated real interest rate is highly variable at short horizons, but comparatively stable at long horizons. Changes in real rates and expected inflation are strongly negatively correlated at short horizons, but not at long horizons.
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49.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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| Posted: |
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04 Feb 01
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Last Revised:
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04 Feb 01
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52 (116,464)
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7
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Abstract:
Error-correction models for cointegrated economic variables are commonly interpreted as reflecting partial adjustment of one variable to another. We show that error-correction models may also arise because one variable forecasts another. Reduced-form estimates of error-correction models cannot be used to distinguish these interpretations. In an application, we show that the estimated coefficients in the Marsh-Merton [1987] error-correction model of dividend behavior in the stock market are roughly implied by a near-rational expectations model wherein dividends are persistent and prices are disturbed by some persistent random noise. These results thus do not demonstrate partial adjustment or "smoothing" by managers, but may reflect little more than the persistence of dividends and the noisiness of prices.
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50.
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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01 Aug 00
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Last Revised:
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02 Apr 08
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51 (117,473)
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158
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Abstract:
This paper proposes and implements a new approach to a classic unsolved problem in financial economics: the optimal consumption and portfolio choice problem of a long-lived investor facing time-varying investment opportunities. The investor is assumed to be infinitely-lived, to have recursive Epstein-Zin-Weil utility, and to choose in discrete time between a riskless asset with a constant return, and a risky asset with constant return variance whose expected log return follows and AR(1) process. The paper approximates the choice problem by log-linearizing the budget constraint and Euler equations, and derives an analytical solution to the approximate problem. When the model is calibrated to US stock market data it implies that intertemporal hedging motives greatly increase, and may even double, the average demand for stocks by investors whose risk-aversion coefficients exceed one.
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51.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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| Posted: |
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06 Apr 04
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Last Revised:
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18 Oct 08
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46 (122,958)
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198
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Abstract:
In a model where a variable Y[sub t] is proportional to the present value, with constant discount rate, of expected future values of a variable y[sub t] the "spread" S[sub t]= Y[sub t] - [theta sub t] will be stationary for some [theta] whether or not y[sub t]must be differenced to induce stationarity. Thus, Y[sub t] and y[sub t] are cointegrated. The model implies that S[sub t] is proportional to the optimal forecast of [delta Y{sub t+1}] and also to the optimal forecast of S*[sub t], the present value of future [delta y{sub t}]. We use vector autoregressive methods, and recent literature on cointegrated processes, to test the model. When Y[sub t] is the long-term interest rate and y[sub t] the short-term interest rate, we find in postwar U.S. data that S[sub t] behaves much like an optimal forecast of S*[sub t] even though as earlier research has shown it is negatively correlated with [delta Y{sub t+1}]. When Y[sub t] is a real stock price index and y[sub t] the corresponding real dividend, using annual U.S. data for 1871-1986 we obtain less encouraging results for the model, al-though the results are sensitive to the assumed discount rate.
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52.
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John Y. Campbell Harvard University - Department of Economics Yasushi Hamao University of Southern California - Marshall School of Business - Finance and Business Economics Department
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| Posted: |
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31 May 01
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Last Revised:
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28 Dec 01
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43 (126,353)
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69
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Abstract:
This paper studies the predictability of monthly excess returns on equity portfolios over the domestic short-term interest rate in the U.S. and Japan during the period 1971:1-1989:3. The paper finds that similar variables, including the dividend-price ratio and interest rate variables, help to forecast excess returns in each country. In addition, in the 1980's U.S. variables help to forecast excess Japanese stock returns. There is evidence of common movement in expected excess returns across the two countries, which is suggestive of integration of long-term capital markets.
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53.
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John Y. Campbell Harvard University - Department of Economics Tarun Ramadorai University of Oxford - Said Business School Tuomo Vuolteenaho Arrowstreet Capital, LP
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| Posted: |
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12 Jul 05
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Last Revised:
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12 Jul 05
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41 (128,738)
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11
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Abstract:
Many questions about institutional trading can only be answered if one can track high-frequency changes in institutional ownership. In the US, however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behavior from the "tape", the Transactions and Quotes database of the New York Stock Exchange, using both a naive approach and a sophisticated method that best matches quarterly 13-F data. Increases in our measures of institutional flows negatively predict returns, particularly when institutions are selling. We interpret this as evidence that 13-F institutions compensate more patient investors for the service of providing liquidity. We also find that both very large and very small trades signal institutional activity, while medium size trades signal activity by the rest of the market.
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54.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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01 Jun 09
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Last Revised:
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15 Jun 09
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40 (129,991)
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3
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Abstract:
This paper explores the history of inflation-indexed bond markets in the US and the UK. It documents a massive decline in long-term real interest rates from the 1990's until 2008, followed by a sudden spike in these rates during the financial crisis of 2008. Breakeven inflation rates, calculated from inflation- indexed and nominal government bond yields, stabilized until the fall of 2008, when they showed dramatic declines. The paper asks to what extent short-term real interest rates, bond risks, and liquidity explain the trends before 2008 and the unusual developments in the fall of 2008. Low inflation-indexed yields and high short-term volatility of inflation-indexed bond returns do not invalidate the basic case for these bonds, that they provide a safe asset for long-term investors. Governments should expect inflation-indexed bonds to be a relatively cheap form of debt financing going forward, even though they have offered high returns over the past decade.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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55.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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18 May 06
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Last Revised:
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18 May 06
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40 (129,991)
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123
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Abstract:
The welfare benefits of financial markets depend in large part on how effectively households use these markets. The study of household finance is challenging because household behavior is difficult to measure accurately, and because households face constraints that are not captured by textbook models, including fixed costs, uninsurable income risk, borrowing constraints, and contracts that are non-neutral with respect to inflation. Evidence on participation, diversification, and the exercise ofmortgage refinancing options suggests that many households are reasonably effective investors, but a minority make significant mistakes. This minority appears to be poorer and less well educated than the majority of more successful investors. There is some evidence that households understand their own limitations, and try to avoid financial strategies that require them to make decisions they do not feel qualified to make. Some financial products involve a cross-subsidy from naive households tosophisticated households, and this can inhibit the emergence of products that would promote effective financial decision making by households.
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56.
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Laurent E. Calvet HEC School of Management - Department of Finance and Economics John Y. Campbell Harvard University - Department of Economics Paolo Sodini Stockholm School of Economics - Department of Finance
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| Posted: |
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17 Feb 09
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Last Revised:
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28 Sep 09
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37 (133,723)
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1
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Abstract:
This paper constructs an index of financial sophistication that, in comprehensive data on Swedish households, best explains a set of three investment mistakes: underdiversification, risky share inertia, and the tendency to sell winning stocks and hold losing stocks (the disposition effect). The index of financial sophistication increases strongly with financial wealth and household size, and to a lesser extent with education and proxies for financial experience. The index is strongly positively correlated with the share of risky assets held by a household.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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57.
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John Y. Campbell Harvard University - Department of Economics Jianping Mei New York University - Department of Finance
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| Posted: |
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27 Apr 00
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Last Revised:
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03 Jan 02
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37 (133,723)
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38
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Abstract:
This paper breaks assets' betas with common factors into components attributable to news about future cash flows, real interest rates, and excess returns. To achieve this decomposition the paper uses a vector autoregressive time-series model and an approximate log-linear present value relation. The betas of industry and size portfolios with the market are largely attributed to changes expected returns. Betas with inflation and industrial production reflect opposing cash flow and expected return effects. The paper also shows how asset pricing theory restricts the expected excess return components of betas.
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58.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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29 Jul 00
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Last Revised:
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29 Jul 00
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33 (139,164)
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139
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Abstract:
This paper proposes a new way to generalize the insights of static asset pricing theory to a multi-period setting. The paper uses a loglinear approximation to the budget constraint to substitute out consumption from a standard intertemporal asset pricing model. In a homoskedastic lognormal setting, the consumption-wealth ratio is shown to depend on the elasticity of intertemporal substitution in consumption, while asset risk premia are determined by the coefficient of relative risk aversion. Risk premia are related to the covariances of asset returns with the market return and with news about the discounted value of all future market returns.
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59.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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01 Aug 00
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Last Revised:
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25 Mar 08
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32 (140,574)
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10
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Abstract:
This paper reviews the behavior of stock prices in relation to consumption. The paper lists some important stylized facts that characterize US data, and relates them to recent developments in equilibrium asset pricing theory. Data from other countries are examined to see which features of the US experience apply more generally. The paper argues that to make sense of stock market behavior one needs a model in which investors' risk aversion is both high and varying, such as the external habit-formation model of Campbell and Cochrane (1995).
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60.
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John Y. Campbell Harvard University - Department of Economics Stefano Giglio Harvard University Parag Pathak Harvard University - Department of Economics
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| Posted: |
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13 Apr 09
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Last Revised:
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17 Apr 09
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30 (143,612)
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4
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Abstract:
This paper uses data on house transactions in the state of Massachusetts over the last 20 years to show that houses sold after foreclosure, or close in time to the death or bankruptcy of at least one seller, are sold at lower prices than other houses. Foreclosure discounts are particularly large on average at 28% of the value of a house. The pattern of death-related discounts suggests that they may result from poor home maintenance by older sellers, while foreclosure discounts appear to be related to the threat of vandalism in low-priced neighborhoods. After aggregating to the zipcode level and controlling for regional price trends, the prices of forced sales are mean-reverting, while the prices of unforced sales are close to a random walk. At the zipcode level, this suggests that unforced sales take place at approximately efficient prices, while forced-sales prices reflect time-varying illiquidity in neighborhood housing markets. At a more local level, however, we find that foreclosures that take place within a quarter of a mile, and particularly within a tenth of a mile, of a house lower the price at which it is sold. Our preferred estimate of this effect is that a foreclosure at a distance of 0.05 miles lowers the price of a house by about 1%.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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61.
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A Scorecard for Indexed Government Debt
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Show Abstracts |
Hide Abstracts |
Versions (2)
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hide multiple versions |
Export Bibliographic Info |
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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Posted:
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01 Oct 96
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Last Revised:
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09 May 00
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30 (143,612) |
29
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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| Posted: |
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01 Oct 96
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Last Revised:
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01 Jan 99
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0
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Abstract:
Within the last five years, Canada, Sweden and New Zealand have joined the ranks of the United Kingdom and other countries in issuing government bonds that are indexed to inflation. Some observers of the experience in these countries have argued that the United States should follow suit. This paper provides an overview of the issues surrounding debt indexation, and it tries to answer three empirical questions about indexed debt. First, how different would the returns on indexed bonds be from the returns on existing US debt instruments? Second, how would indexed bonds affect the government's average financing costs? Third, how might the Federal Reserve be able to use the information contained in the prices of indexed bonds to help formulate monetary policy? The paper concludes with a more speculative discussion of the possible consequences of increased use of indexed debt contracts by the private sector.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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| Posted: |
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03 Aug 98
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Last Revised:
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09 May 00
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30
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29
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| |
Abstract:
Within the last five years, Canada, Sweden and New Zealand have joined the ranks of the United Kingdom and other countries in issuing government bonds that are indexed to inflation. Some observers of the experience in these countries have argued that the United States should follow suit. This paper provides an overview of the issues surrounding debt indexation, and it tries to answer three empirical questions about indexed debt. First, how different would the returns on indexed bonds be from the returns on existing US debt instruments? Second, how would indexed bonds affect the government's average financing costs? Third, how might the Federal Reserve be able to use the information contained in the prices of indexed bonds to help formulate monetary policy? The paper concludes with a more speculative discussion of the possible consequences of increased use of indexed debt contracts by the private sector.
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62.
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John Y. Campbell Harvard University - Department of Economics John H. Cochrane University of Chicago Booth School of Business
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| Posted: |
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24 Jul 00
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Last Revised:
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22 Apr 08
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27 (149,036)
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494
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Abstract:
We present a consumption-based model that explains the procyclical variation of stock prices, the long-horizon predictability of excess stock returns, and the countercyclical variation of stock market volatility. Our model has an i.i.d. consumption growth driving process, and adds a slow-moving external habit to the standard power utility function. The latter feature produces cyclical variation in risk aversion, and hence in the prices of risky assets. Our model also predicts many of the difficulties that beset the standard power utility model, including Euler equation rejections, no correlation between mean consumption growth and interest rates, very high estimates of risk aversion, and pricing errors that are larger than those of the static CAPM. Our model captures much of the history of stock prices, given only consumption data. Since our model captures the equity premium, it implies that fluctuations have important welfare costs. Unlike many habit-persistence models, our model does not necessarily produce cyclical variation in the risk free interest rate, nor does it produce an extremely skewed distribution or negative realizations of the marginal rate of substitution.
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63.
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John Y. Campbell Harvard University - Department of Economics John H. Cochrane University of Chicago Booth School of Business
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| Posted: |
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26 Apr 00
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Last Revised:
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05 May 00
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27 (149,036)
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80
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Abstract:
The poor performance of consumption-based asset pricing models relative to traditional portfolio-based asset pricing models is one of the great disappointments of the empirical asset pricing literature. We show that the external habit-formation model economy of Campbell and Cochrane (1999) can explain this puzzle. Though artificial data from that economy conform to a consumption-based model by construction, the CAPM and its extensions are much better approximate models than is the standard power utility specification of the consumption-based model. Conditioning information is the central reason for this result. The model economy has one shock, so when returns are measured at sufficiently high frequency the consumption-based model and the CAPM are equivalent and perfect conditional asset pricing models. However, the model economy also produces time-varying expected returns, tracked by the dividend-price ratio. Portfolio-based models capture some of this variation in state variables, which a state-independent function of consumption cannot capture, and so portfolio-based models are better approximate unconditional asset pricing models.
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64.
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John Y. Campbell Harvard University - Department of Economics Kenneth Froot National Bureau of Economic Research (NBER)
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| Posted: |
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27 Dec 02
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Last Revised:
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06 Sep 08
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26 (151,129)
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9
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Abstract:
This paper studies the international experience with securities transaction taxes (STTs), using the Swedish and British systems as case studies. We argue that STTs are best thought of as taxes on different resources used in transactions: domestic brokerage services in the case of Sweden, and registration services in the British case. STTs give investors incentives to economize on the taxed resources by shifting trading to foreign markets or untaxed assets, or by reducing the volume of trade. We show that these effects can be important. Estimated revenues from an STT will be correspondingly overstated if they ignore such behavioral effects.
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65.
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John Y. Campbell Harvard University - Department of Economics Robert J. Shiller Yale University - Cowles Foundation
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| Posted: |
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09 Mar 04
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Last Revised:
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09 Mar 04
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25 (153,405)
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7
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Abstract:
No abstract is available for this paper.
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66.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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01 Feb 01
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Last Revised:
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17 Apr 08
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25 (153,405)
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16
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Abstract:
Expectations theories of asset returns may be interpreted as stating either that risk premia are zero, or that they are constant through time. Under the former interpretation, different versions of the expectations theory of the term structure are inconsistent with one another, but I show that this does not necessarily carry over to the constant risk premium interpretation of the theory. Furthermore, I argue that differences among expectations theories are of "second order" in a precise mathematical sense. I present an approximate linearized framework for analysis of the term structure in which these differences disappear, and I test its accuracy in practice using data from the CRSP government bond tapes.
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67.
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Jason Beeler Harvard University - Department of Economics John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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17 Mar 09
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Last Revised:
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17 Mar 09
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24 (155,828)
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4
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Abstract:
The long-run risks model of asset prices explains stock price variation as a response to persistent fluctuations in the mean and volatility of aggregate consumption growth, by a representative agent with a high elasticity of intertemporal substitution. This paper documents several empirical difficulties for the model as calibrated by Bansal and Yaron (BY, 2004) and Bansal, Kiku, and Yaron (BKY, 2007a). BY's calibration counterfactually implies that long-run consumption and dividend growth should be highly persistent and predictable from stock prices. BKY's calibration does better in this respect by greatly increasing the persistence of volatility fluctuations and their impact on stock prices. This calibration fits the predictive power of stock prices for future consumption volatility, but implies much greater predictive power of stock prices for future stock return volatility than is found in the data. Neither calibration can explain why movements in real interest rates do not generate strong predictable movements in consumption growth. Finally, the long-run risks model implies extremely low yields and negative term premia on inflation-indexed bonds.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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68.
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John Y. Campbell Harvard University - Department of Economics Yves Nosbusch London School of Economics
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| Posted: |
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25 May 06
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Last Revised:
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23 Jun 06
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24 (155,828)
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4
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Abstract:
In the presence of overlapping generations, markets are incomplete because it is impossible to engage in risksharing trades with the unborn. In such an environment the government can use a social security system, with contingent taxes and benefits, to improve risksharing across generations. An interesting question is how the form of the social security system affects asset prices in equilibrium. In this paper we set up a simple model with two risky factors of production: human capital, owned by the young, and physical capital, owned by all older generations. We show that a social security system that optimally shares risks across generations exposes future generations to a share of the risk in physical capital returns. Such a system reduces precautionary saving and increases the risk-bearing capacity of the economy. Under plausible conditions it increases the riskless interest rate, lowers the price of physical capital, and reduces the risk premium on physical capital.
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69.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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12 Apr 04
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Last Revised:
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12 Apr 04
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23 (158,402)
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64
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Abstract:
No abstract is available for this paper.
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70.
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John Y. Campbell Harvard University - Department of Economics N. Gregory Mankiw Harvard University - Department of Economics
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| Posted: |
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04 Apr 04
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Last Revised:
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04 Apr 04
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22 (161,110)
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27
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Abstract:
No abstract is available for this paper.
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71.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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04 Apr 04
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Last Revised:
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09 Oct 08
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21 (163,960)
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35
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Abstract:
No abstract is available for this paper.
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72.
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John Y. Campbell Harvard University - Department of Economics Adi Sunderam Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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17 Feb 09
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Last Revised:
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17 Feb 09
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19 (169,706)
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15
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| |
Abstract:
The covariance between US Treasury bond returns and stock returns has moved considerably over time. While it was slightly positive on average in the period 1953-2005, it was particularly high in the early 1980's and negative in the early 2000's. This paper specifies and estimates a model in which the nominal term structure of interest rates is driven by five state variables: the real interest rate, risk aversion, temporary and permanent components of expected inflation, and the covariance between nominal variables and the real economy. The last of these state variables enables the model to fit the changing covariance of bond and stock returns. Log nominal bond yields and term premia are quadratic in these state variables, with term premia determined mainly by the product of risk aversion and the nominal-real covariance. The concavity of the yield curve - the level of intermediate-term bond yields, relative to the average of short- and long-term bond yields - is a good proxy for the level of term premia. The nominal-real covariance has declined since the early 1980's, driving down term premia.
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73.
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John Y. Campbell Harvard University - Department of Economics N. Gregory Mankiw Harvard University - Department of Economics
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| Posted: |
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10 Jul 07
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Last Revised:
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10 Jul 07
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18 (172,515)
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16
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Abstract:
No abstract is available for this paper.
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74.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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03 Jul 07
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Last Revised:
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15 Jan 09
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15 (181,153)
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5
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Abstract:
No abstract is available for this paper.
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75.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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10 Jun 00
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Last Revised:
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10 Jun 00
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15 (181,153)
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20
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Abstract:
This paper studies tests of predictability in regressions with a given AR(1) regressor and an asset return dependent variable measured over a short or long horizon. The paper shows that when there is a persistent predictable component in the return, an increase in the horizon may increase the R2 statistic of the regression and the approximate slope of a predictability test. Mone Carlo experiments show that long-horizon regression tests have serious size distortions when asymptotic critical values are used, but some versions of such tests have power advantages remaining after size is corrected.
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76.
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Laurent E. Calvet HEC School of Management - Department of Finance and Economics John Y. Campbell Harvard University - Department of Economics Paolo Sodini Stockholm School of Economics - Department of Finance
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| Posted: |
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21 Jul 08
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Last Revised:
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14 Aug 08
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13 (186,934)
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14
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Abstract:
This paper investigates the dynamics of individual portfolios in a unique dataset containing the disaggregated wealth of all households in Sweden. Between 1999 and 2002, we observe little aggregate rebalancing in the financial portfolio of participants. These patterns conceal strong household-level evidence of active rebalancing, which on average offsets about one half of idiosyncratic passive variations in the risky asset share. Wealthy, educated investors with better diversified portfolios tend to rebalance more actively. We find some evidence that households rebalance towards a higher risky share as they become richer. We also study the decisions to trade individual assets. Households are more likely to fully sell directly held stocks if those stocks have performed well, and more likely to exit direct stockholding if their stock portfolios have performed well; but these relationships are much weaker for mutual funds, a pattern which is consistent with previous research on the disposition effect among direct stockholders and performance sensitivity among mutual fund investors. When households continue to hold individual assets, however, they rebalance both stocks and mutual funds to offset about one sixth of the passive variations in individual asset shares. Households rebalance primarily by adjusting purchases of risky assets if their risky portfolios have performed poorly, and by adjusting both fund purchases and full sales of stocks if their risky portfolios have performed well. Finally, the tendency for households to fully sell winning stocks is weaker for wealthy investors with diversified portfolios of individual stocks.
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77.
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John Y. Campbell Harvard University - Department of Economics Richard H. Clarida Columbia University, Graduate School of Arts and Sciences, Department of Economics
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11 Apr 07
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Last Revised:
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10 Jan 08
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13 (186,934)
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4
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Abstract:
This paper is an empirical investigation of the predictability and comovement of risk premia in the term structure of Euromarket interest rates. We show that variables which have been used as proxies for risk premia on uncovered foreign asset positions also predict excess returns in Euroniarket term structures, while variables which have been used as proxies for risk premia in the term structure also predict excess returns on taking uncovered foreign asset positions. These findings suggests that risk premia in the Euromarket term structures and on uncovered foreign asset positions move together. We test formally the hypothesis that risk premia on uncovered 3-month EuroDM and Eurosterling deposits move in proportion to a single latent variable. We are unable to reject this hypothesis. We are also unable to reject the hypothesis that the risk premia on these three strategies and those on rolling over 1-month Eurosterling (EuroDM) deposits versus holding a 3-month Eurosterlirig (EuroDN) deposit move in proportion to a single latent variable. The single latent variable model can be interpreted atheoretically, as a way of characterizing the extent to which predictable asset returns move together; or it can be interpreted as in Hansen and Hodrick (1983) and Hodrick and Srivastava (1983) as a specialization of the ICAPM in which assets have constant betas on a single, unobservable benchmark portfolio.
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78.
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John Y. Campbell Harvard University - Department of Economics Richard H. Clarida Columbia University, Graduate School of Arts and Sciences, Department of Economics
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| Posted: |
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15 Jan 07
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Last Revised:
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15 Jan 07
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12 (189,813)
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Abstract:
Recent theoretical research in open-economy macroeconomics has emphasized the connection between a country`s current account and the intertemporal savings and investment choices of its households, firms, and governments. In this paper, we assess the empirical relevance of the permanent income theory of household saving, a key building block of recent theoretical models of the current account. Using the econometric approach of Campbell (1987), we are able to reject the theory on quarterly aggregate data in Canada and the United Kingdom. However, we also assess the economic significance of these statistical rejections by comparing the behavior of saving with that of an unrestricted vector autoregressive (VAR) forecast of future changes in disposable labor income. If the theory is true, saving should be the best available predictor of future changes in disposable labor income. We find the correlation between saving and the unrestricted VAR forecast to be extremely high in both countries. The results suggest that the theory provides a useful description of the dynamic behavior of household saving in Canada and Britain.
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79.
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John Y. Campbell Harvard University - Department of Economics
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19 Jun 04
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Last Revised:
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19 Jun 04
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12 (189,813)
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22
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Abstract:
No abstract is available for this paper.
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80.
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John Y. Campbell Harvard University - Department of Economics
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| Posted: |
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11 Jan 08
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Last Revised:
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12 Feb 08
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8 (200,697)
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8
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Abstract:
Finance theory restricts the time-series behaviour of valuation ratios and links the cross-section of stock prices to the level of the equity premium. This can be used to strengthen the evidence for predictability in stock returns. Steady-state valuation models are useful predictors of stock returns, given the persistence in valuation ratios. A steady-state approach suggests that the world geometric average equity premium fell considerably in the late twentieth century, rose modestly in the early years of the twenty-first century, and was almost 4% at the end of March 2007.
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81.
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John Y. Campbell Harvard University - Department of Economics Samuel Brodsky Thompson Arrowstreet Capital, L.P.
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08 Aug 08
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Last Revised:
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25 Feb 09
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5 (207,450)
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28
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Abstract:
Goyal and Welch (2007) argue that the historical average excess stock return forecasts future excess stock returns better than regressions of excess returns on predictor variables. In this article, we show that many predictive regressions beat the historical average return, once weak restrictions are imposed on the signs of coefficients and return forecasts. The out-of-sample explanatory power is small, but nonetheless is economically meaningful for mean-variance investors. Even better results can be obtained by imposing the restrictions of steady-state valuation models, thereby removing the need to estimate the average from a short sample of volatile stock returns.
G10, G11
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82.
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John Y. Campbell Harvard University - Department of Economics Tarun Ramadorai University of Oxford - Said Business School Allie Schwartz Harvard University
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| Posted: |
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29 May 08
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Last Revised:
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29 May 08
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2 (213,370)
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10
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Abstract:
Many questions about institutional trading can only be answered if one can track high-frequency changes in institutional ownership. In the U.S., however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behaviour from the "tape", the Transactions and Quotes database of the New York Stock Exchange, using a sophisticated method that best matches quarterly 13-F data. We find that daily institutional trades are highly persistent and respond positively to recent daily returns but negatively to longer-term past daily returns. Institutional trades, particularly sells, appear to generate short-term losses - possibly reflecting institutional demand for liquidity - but longer-term profits. One source of these profits is that institutions anticipate both earnings surprises and post-earnings-announcement drift. These results are different from those obtained using a standard size cutoff rule for institutional trades.
Earnings announcements, institutions, liquidity, post-earnings-announcement-drift, trading
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83.
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Laurent E. Calvet HEC School of Management - Department of Finance and Economics John Y. Campbell Harvard University - Department of Economics Paolo Sodini Stockholm School of Economics - Department of Finance
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| Posted: |
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21 Dec 07
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21 Dec 07
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0 (0)
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Abstract:
This paper investigates the efficiency of household investment decisions using comprehensive disaggregated Swedish data. We consider two main sources of inefficiency: underdiversification ("down") and nonparticipation in risky asset markets ("out"). While a few households are very poorly diversified, most Swedish households outperform the Sharpe ratio of their domestic stock index through international diversification. Financially sophisticated households invest more efficiently but also more aggressively, and overall they incur higher return losses from underdiversification. The return cost of nonparticipation is smaller by almost one-half when we take account of the fact that nonparticipants would unlikely be inefficient investors.
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84.
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John Y. Campbell Harvard University - Department of Economics Ludger Hentschel Simon School, University of Rochester
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| Posted: |
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16 Jul 07
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Last Revised:
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19 Jan 09
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0 (215,502)
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Abstract:
No abstract is available for this paper.
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85.
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John Y. Campbell Harvard University - Department of Economics Luis M. Viceira Harvard Business School - Finance Unit
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| Posted: |
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05 Feb 05
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Last Revised:
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18 Nov 08
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0 (0)
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Abstract:
Expected excess returns on bonds and stocks, real interest rates, and risk shift over time in predictable ways. Furthermore, these shifts tend to persist for long periods. Changes in investment opportunities can alter the risk-return trade-off of bonds, stocks, and cash across investment horizons, thus creating a term structure of the risk-return trade-off. This term structure can be extracted from a parsimonious model of return dynamics, as is illustrated with data from the U.S. stock and bond markets.
Portfolio Management, Asset Allocation, Investment Theory, Portfolio Theory
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86.
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John Y. Campbell Harvard University - Department of Economics Kenneth Froot National Bureau of Economic Research (NBER)
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| Posted: |
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02 Sep 99
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Last Revised:
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19 Jan 09
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0 (0)
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Abstract:
This paper studies the international experience with securities transaction taxes (STTs), using the Swedish and British systems as case studies. We argue that STTs are best thought of as taxes on different resources used in transactions: domestic brokerage services in the case of Sweden, and registration services in the British case. STTs give investors incentives to economize on the taxed resources by shifting trading to foreign markets or untaxed assets, or by reducing the volume of trade. We show that these effects can be important. Estimated revenues from an STT will be correspondingly overstated if they ignore such behavioral effects.
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87.
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John Y. Campbell Harvard University - Department of Economics John H. Cochrane University of Chicago Booth School of Business
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| Posted: |
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15 Mar 99
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Last Revised:
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19 Mar 09
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0 (0)
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Abstract:
We present a consumption-based model that explains a wide variety of dynamic asset pricing phenomena, including the procyclical variation of stock prices, the long-horizon predictability of excess stock returns, and the countercyclical variation of stock market volatility. The model captures much of the history of stock prices from consumption data. It explains the short- and long-run equity premium puzzles despite a low and constant risk-free rate. The results are essentially the same whether we model stocks as a claim to the consumption stream or as a claim to volatile dividends poorly correlated with consumption. The model is driven by an independently and identically distributed consumption growth process and adds a slow-moving external habit to the standard power utility function. These features generate slow countercyclical variation in risk premia. The model posits a fundamentally novel description of risk premia: Investors fear stocks primarily because they do poorly in recessions unrelated to the risks of long-run average consumption growth.
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