Asset Prices and Capital Share Risks: Theory and Evidence

Byrne, Joseph P and Ibrahim, Boulis Maher and Zong, Xiaoyu (2020): Asset Prices and Capital Share Risks: Theory and Evidence.

Abstract

Pricing of capital share risks provides a novel link between macroeconomics and finance. Our paper adopts the Epstein-Zin type utility framework and the Bansal and Yaron’s (2004) long-run risk model to derive an heterogeneous asset pricing model that extends Lettau et al.’s (2019) capital share study. Our model introduce heterogeneity within the stock market and highlights the role of elevated consumption volatility of high income stockholders in capital risks. We also uncover contracting evidences as the capital share growth has strong volatility effects in the short-run and capital share variability enters systematic risks in the long-run.

• Item Type: MPRA Paper
• Language: English
• Keywords: Asset Pricing, Capital Share, Recursive Preference, Consumption Growth, Bayesian Methods.
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C21 - Cross-Sectional Models ; Spatial Models ; Treatment Effect Models ; Quantile Regressions; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C30 - General; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E25 - Aggregate Factor Income Distribution; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates

References

Abel, A. B. (1999). Risk premia and term premia in general equilibrium. Journal of Monetary Economics, 43(1):3–33.

Andrews, D. W. (2004). The block–block bootstrap: improved asymptotic refinements. Econometrica, 72(3):673–700.

Bansal, R. and Yaron, A. (2004). Risks for the long run: A potential resolution of asset pricing puzzles. Journal of Finance, 59(4):1481–1509.

Bianchi, D., Guidolin, M., and Ravazzolo, F. (2017). Macroeconomic factors strike back: A Bayesian change-point model of time-varying risk exposures and premia in the us cross-section. Journal of Business & Economic Statistics, 35(1):110–129.

Boguth, O. and Kuehn, L.-A. (2013). Consumption volatility risk. Journal of Finance, 68(6):2589–2615.

Borovicka, J. (2020). Survival and long-run dynamics with heterogeneous beliefs under recursive preferences. Journal of Political Economy, Forthcoming.

Bournay, J. and Laroque, G. (1979). Réflexions sur la méthode d’elaboration des comptes trimestriels. In Annales de l’INSEE, pages 3–30. JSTOR.

Breeden, D. T. (1979). An intertemporal asset pricing model with stochastic consumption and investment opportunities. Journal of Financial Economics, 7(3):265–296.

Breeden, D. T., Litzenberger, R. H., and Jia, T. (2014). Consumption-based asset pricing: research and applications. Annual Review of Financial Economics, 7:35–83.

Campbell, J. Y. (1999). Asset prices, consumption, and the business cycle. Handbook of Macroeconomics, 1:1231–1303.

Campbell, J. Y. and Cochrane, J. H. (1999). By force of habit: A consumption-based explanation of aggregate stock market behavior. Journal of Political Economy, 107(2):205– 251.

Campbell, J. Y. and Cochrane, J. H. (2000). Explaining the poor performance of consumption-based asset pricing models. Journal of Finance, 55(6):2863–2878.

Campbell, J. Y., Grossman, S. J., and Wang, J. (1993). Trading volume and serial correlation in stock returns. The Quarterly Journal of Economics, 108(4):905–939.

Campbell, J. Y. and Shiller, R. J. (1988a). The dividend-price ratio and expectations of future dividends and discount factors. Review of Financial Studies, 1(3):195–228.

Campbell, J. Y. and Shiller, R. J. (1988b). Stock prices, earnings, and expected dividends. Journal of Finance, 43(3):661–676.

Chabi-Yo, F., Leisen, D. P., and Renault, E. (2014). Aggregation of preferences for skewed asset returns. Journal of Economic Theory, 154:453–489.

Chow, G. and Lin, A.-l. (1971). Best linear unbiased interpolation, distribution, and extrapolation of time series by related series. The Review of Economics and Statistics, 53(4):372–75.

Cochrane, J. H. (2009). Asset Pricing: Revised edition. Princeton University Press.

Colacito, R., Croce, M. M., Liu, Y., and Shaliastovich, I. (2018). Volatility risk pass-through. https://www.nber.org/papers/w25276.

Constantinides, G. M. and Duffie, D. (1996). Asset pricing with heterogeneous consumers. Journal of Political Economy, 104(2):219–240.

Epstein, L. G. and Zin, S. E. (1989). Substitution, risk aversion, and the temporal behavior of consumption. Econometrica, 57(4):937–969.

Fama, E. F. and French, K. R. (1988). Permanent and temporary components of stock prices. Journal of Political Economy, 96(2):246–273.

Fama, E. F. and French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33:3–56.

Fama, E. F. and MacBeth, J. D. (1973). Risk, return, and equilibrium: Empirical tests. Journal of Political Economy, 81(3):607–636.

Fernandez, R. B. (1981). A methodological note on the estimation of time series. The Review of Economics and Statistics, 63(3):471–476.

FRED (2019a). Personal income. https://fred.stlouisfed.org/series/PI.

FRED (2019b). Release tables: Personal income and its disposition, monthly. https: //fred.stlouisfed.org/release/tables?rid=54&eid=155443&od=2011-12-01#.

Gabaix, X., Lasry, J.-M., Lions, P.-L., and Moll, B. (2016). The dynamics of inequality. Econometrica, 84(6):2071–2111.

Gerlach, R., Carter, C., and Kohn, R. (2000). Efficient bayesian inference for dynamic mixture models. Journal of the American Statistical Association, 95(451):819–828.

Geweke, J. (1991). Evaluating the accuracy of sampling-based approaches to the calculation of posterior moments, volume 196. Staff Report 148, Federal Reserve Bank of Minneapolis.

Gomme, P. and Rupert, P. (2004). Measuring labor’s share of income. FRB of Cleveland Policy Discussion Paper, (7).

Greenwald, D. L., Lettau, M., and Ludvigson, S. C. (2014). Origins of stock market fluctuations. Technical report, NBER Working Paper No. 19818.

Hall, P., Horowitz, J. L., and Jing, B.-Y. (1995). On blocking rules for the bootstrap with dependent data. Biometrika, 82(3):561–574.

Horowitz, J. L. (1997). Bootstrap methods in econometrics: theory and numerical performance. Econometric Society Monographs, 28:188–222.

Huber, F., Koop, G., and Onorante, L. (2020). Inducing sparsity and shrinkage in time-varying parameter models. Journal of Business & Economic Statistics, pages 1–15.

Jagannathan, R. and Wang, Z. (1996). The conditional CAPM and the cross-section of expected returns. Journal of Finance, 51(1):3–53.

Jensen, M. C. (1968). The performance of mutual funds in the period 1945–1964. Journal of Finance, 23(2):389–416.

Judge, G. G., Hill, R. C., Griffiths, W. E., Lütkepohl, H., and Lee, T.-C. (1988). Introduction to the Theory and Practice of Econometrics. J. Wiley.

Lamont, O. A. (2001). Economic tracking portfolios. Journal of Econometrics, 105(1):161–184.

Lettau, M. and Ludvigson, S. (2001). Resurrecting the (C) CAPM: A cross-sectional test when risk premia are time-varying. Journal of Political Economy, 109(6):1238–1287.

Lettau, M., Ludvigson, S. C., and Ma, S. (2019). Capital share risk in us asset pricing. Journal of Finance, 74(4):1753–1792.

Lewellen, J. and Nagel, S. (2006). The conditional CAPM does not explain asset-pricing anomalies. Journal of Financial Economics, 82(2):289–314.

Litterman, R. B. (1983). A random walk, markov model for the distribution of time series. Journal of Business & Economic Statistics, 1(2):169–173. Mehra, R. and Prescott, E. C. (1985). The equity premium: A puzzle. Journal of Monetary Economics, 15(2):145–161.

Omori, Y., Chib, S., Shephard, N., and Nakajima, J. (2007). Stochastic volatility with leverage: Fast and efficient likelihood inference. Journal of Econometrics, 140(2):425–449.

Saez, E. and Zucman, G. (2016). Wealth inequality in the United States since 1913: Evidence from capitalized income tax data. The Quarterly Journal of Economics, 131(2):519–578.

Toda, A. A. and Walsh, K. J. (2019). The Equity Premium and the One Percent. Review of Financial Studies. hhz121.