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What it studies?
- Macro finance studies the relationships between asset prices (e.g. the level of the stock market) and economic conditions (e.g. whether we’re in a recession or a boom).
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Basic idea
- the market’s ability to bear risk is greater in good times, and less in bad times.
- how macro-finance models can fundamentally alter macroeconomics, by putting time-varying risk premiums and risk-bearing capacity at the center of recessions rather than variation in the interest rate and intertemporal substitution.
- Need to identify what these “bad times” are.
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Explain the facts
- Asset prices are so volatile, as documented by the line of research that ultimately won Bob Shiller the (joint) 2013 Nobel Prize in Economics.
- The equity premium is so high – why stocks offer so high returns compared to Treasury bills – because stocks may perform badly precisely at bad times.
- Asset returns are predictable, i.e. “good/bad times” predict future returns.
- The standard consumption-based asset pricing model argues that good/bad times are defined purely by consumption growth. Bad times are times in which consumption is low, and so the investor is in real need of money. If stocks do badly in times when consumption is low, then stocks are risky and investors will demand a high expected return. But, consumption just isn’t volatile enough in reality to explain the high equity premium we observe in the data – the famous equity premium puzzle of Mehra and Prescott (1985).
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Methods used
- Habits
- Long-Run Risks : Bansal and Yaron (2004) – “bad times” are not times in which consumption is low compared to the habit level, but times in which the investor also receives bad news about long-run future consumption growth.
- Idiosyncratic Risk
- Heterogeneous Preferences: Garleanu and Panageas (2015) – “bad times” are times in which investors who hold most stock become more risk averse.
- Intermediary Asset Pricing: He and Krishnamurthy (2013) – intermediaries (such as banks) are the key investor, and “bad times” are times in which intermediaries are close to bankruptcy and so become risk averse.
- Behavioral Models: In behavioral models, investors form expectations in irrational ways, and “bad times” are times in which expected future returns are (irrationally) low. For example, in Barberis et al. (2015), investors over-extrapolate from past returns.
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What it studies?
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Basic idea
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Methods used
Useful data sources
FRED Download, graph, and track 819,000 US and international time series from 110 sources.
Consumer Sentiment Index - University of Michigan
- What it studies?
- Empirical Macro study with fat data(
#variables >> T
) - In macroeconomics, the challenges which arise in the presence of Big Data are magnified by the fact that our models typically must include parameter change. For instance, the reduction of the volatilities of many macroeconomic variables for many countries, often known as the Great Moderation of the business cycle, which began in the early 1980s before being reversed by the Great Recession, means that econometric models should have time-varying error variances.
- Empirical Macro study with fat data(
- Basic idea *
- Methods used
- Overcome the problem of conventional econometric methods: use of prior shrinkage or through model averaging.
- Least absolute shrinkage and selection operator (LASSO), can be interpreted either in a Bayesian or frequentist2 fashion.