Working Papers

[3] "The Subjective Risk and Return Expectations of Institutional Investors" (with Spencer Couts and Andrei Goncalves)

We use the long-term Capital Market Assumptions of major asset managers and institutional investor consultants from 1987 to 2022 to study their subjective risk and return expectations across 19 asset classes. These beliefs demonstrate a strong positive risk-return tradeoff, with the vast majority of variability in expected returns coming from subjective risk premia (market beta compensation) rather than subjective alphas. Belief variation and the risk-return tradeoff are stronger across asset classes than across institutions. Also, subjective expected returns predict future realized returns across asset classes and over time, with most of this predictability driven by subjective risk premia, not alphas.

[2] "The Idiosyncratic Financial Factor: An Explanation for the Role of Size Factors and the Weak Intertemporal Risk-Return Relation" (with Sung Je Byun and Lawrence Schmidt)

In addition to a priced, dominant market factor (DMF), the value-weighted stock market return contains an “idiosyncratic financial factor” (IFF) related to overweighting of large-  cap stocks. The IFF carries no risk premium, is unrelated to macroeconomic factors and returns in other markets, and significantly impacts systematic risk estimates. Size factors separate exposures to the DMF from the IFF. Consistent with a model with nontraded assets, using the DMF as an alternative market factor resolves the size anomaly and obviates the need for size factors in multifactor models. Finally, the DMF generates a stronger intertemporal risk-return tradeoff.

[1] "Institutional Investors' Subjective Risk Premia: Time Variation and Disagreement" (with Spencer Couts, Andrei Goncalves, and Yicheng Liu)

In this paper, we study the role of subjective risk premia in explaining subjective expected return time variation and disagreement using the long-term Capital Market Assumptions of major asset managers and investment consultants from 1987 to 2022. We find that market risk premia explain most of the expected return time variation, with the rest explained by alphas. The risk premia effect is almost entirely driven by time variation in risk quantities as opposed to risk price. Nevertheless, risk price explains about half of the transitory effect of risk premia on expected returns. Market risk premia also explain most of the expected return disagreement, but in this case alphas have a quantitatively significant effect, and risk price and risk quantities are roughly equally responsible for the risk premia effect. Our results provide benchmark moments that asset pricing models should match to be consistent with institutional investors' beliefs.

Work in Progress

[1] "Idiosyncratic Labor Income in a Production General Equilibrium Model" (with Miguel Palacios and Lawrence Schmidt)

We develop a highly tractable, general equilibrium model with production and incomplete markets. In the model, agents can invest in physical capital and human capital, where the latter investment technology is subject to uninsurable, idiosyncratic disaster risk. The quantity of both inputs is time-varying and endogenously determined in equilibrium, subject to aggregate adjustment costs. We demonstrate that the presence of uninsurable risk has first-order implications for the riskiness of human capital; in particular, the risk premium on human capital and the share of total wealth in human capital are considerably larger and smaller, respectively, relative to the complete markets benchmark. Moreover, the presence of state-dependent, idiosyncratic risk increases the equity risk premium and has important implications for agent's optimal investment behavior.