Size
and Power in Asset Pricing Tests
With Rish Singhania
June 25, 2018
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Causal
Inference (monograph)
November 27, 2018
Implementation-Neutral
Causation in Structural Models
Analysts associated with the Cowles Commission attached great importance
to the distinction between structural and reduced-form models: in their view
structural models, but not reduced-form models, allow the analysis of causal
relations. They did not present clear justification for this view. Here we show
that this insight is correct, and make the demonstration of it precise. Causal
relations are shown to depend on parameter restrictions that are explicit in
the structural form, but not in the reduced form when the coefficients are
interpreted as unrestricted constants. The requisite parameter restrictions are
those associated with implementation-neutral causation. A graphical procedure
is outlined that identifies causal orderings and also the orderind
on implementation-neutral causation. The same procedure applied to reduced form
models produces the implementation-neutral causal ordering only if the
parameter restrictions are explicitly incorporated in the reduced form. The
analysis is applied in investigating the validity of the causal Markov
condition.
JEL Codes B16, B41, C18, C40
Keywords: causation, correlation, regression, Cowles, implementation
neutrality, external variables, internal variables
March 7, 2018
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Capital Market
Efficiency – A Reinterpretation (with Kevin J. Lansing)
In Fama's classic definition, capital markets
are efficient if asset prices fully reflect available information. One
implementation of this definition identifies efficiency with the condition that
future excess returns are unforecastable. The result of this paper is that, in
a broad class of models, this condition is satisfied if conditional variances
of shocks are constant across states. This result occurs even if agents are
risk averse, in contrast to the situation that obtains when efficiency is
identified with returns rather than excess returns. A model that exemplifies the
result is discussed.
November 30, 2016
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Implementation-Neutral
Causation and Treatment Evaluation
Statisticians have
proposed formal techniques for evaluation of treatments, often in the context
of models that do not explicitly specify how treatments are generated. Under
such procedures they run the risk of attributing causation in settings where
the implementation neutrality condition required for causal interpretation of
parameter estimates is not satisfied. When treatment assignments are explicitly
modeled, as economists recommend, these issues can be formally analyzed, and
the existence (or lack thereof) of implementation neutrality, and therefore
quantifiable causation, can be determined.
Examples are given.
June 28, 2017
Implementation-Neutral
Causation
The most basic
question one can ask of a model is "What is the effect on variable y₂ of variable y₁?" Causation is "implementation
neutral" when all interventions on external variables that lead to a given
change in y₁ have the same effect on y₂, so that the effect of y₁ on y₂ is defined unambiguously. Familiar ideas of causal analysis do not apply
when causation is implementation neutral. For example, a cause variable cannot
be linked to an effect variable by both a direct path and a distinct indirect
path. Discussion of empirical aspects of implementation neutrality leads to
further unexpected results, such as that if one variable causes another the
coefficient representing that causal link is always identified.
July 25, 2015
Deposit Insurance
and the Coexistence of Commercial and Shadow Banks
(with Hrishikesh Singhania)
We consider a general equilibrium model in which a government insurer
guarantees deposits at commercial banks, but not at shadow banks. When deposit
insurance is financed via lump-sum taxes, commercial banks dominate in
equilibrium. These banks shift risk to the insurer by holding high levels of
risky assets, leading to overvaluation of these assets. We also determine the
equilibrium when deposit insurance is financed using deposit-based or
risky-asset-based insurance premia. In both cases, we
find that the asset price distortion induced by subsidized deposit insurance
can indirectly benefit shadow banks, by allowing these banks to trade to their
advantage. As a consequence, insured commercial banks and uninsured shadow
banks coexist under subsidized deposit insurance. The asset price distortion is
eliminated when the aggregate subsidy to unsuccessful commercial banks equals
the aggregate penalty to successful banks. In all three financing regimes,
capital requirements on commercial banks reduce the asset price distortion due
to deposit insurance.
July 5, 2017
Risk Aversion,
Investor Information and Stock Market Volatility
(with Kevin J. Lansing)
European Economic
Review 2014
Mortgage Default
and Mortgage Valuation
(with John Krainer and Munpyung O)
We study optimal
exercise by mortgage borrowers of the option to default. Also, we use an
equilibrium valuation model incorporating default to show how mortgage yields
and lender recovery rates on defaulted mortgages depend on initial
loan-to-value ratios when borrowers default optimally. The analysis treats both
the frictionless case and the case in which borrowers and/or lenders incur
deadweight costs upon default. The model is calibrated using data on
November 2, 2009
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Infinite Portfolio
Strategies
In continuous-time stochastic
calculus a limit in probability is used to extend the definition of the
stochastic integral to the case where the integrand is not square-integrable at the endpoint of the time interval under
consideration. When the extension is applied to portfolio strategies, absence
of arbitrage in finite portfolio strategies is consistent with existence of
arbitrage in infinite portfolio strategies. The doubling strategy is the most
common example. We argue that this extension may or may not make economic sense,
depending on whether or not one thinks that valuation should be continuous. We
propose an alternative extension of the definition of the stochastic integral
under which valuation is continuous and absence of arbitrage is preserved. The
extension involves appending a date and state called ∞ to the payoff
index set and altering the definition of convergence under which gains on
infinite portfolio strategies are defined as limits of gains on finite
portfolio strategies.
March 14, 2012
Contemporary Economics, 2012
The MM
Propositions in the Presence of Bubbles
The Miller-Modigliani dividend irrelevance
proposition states that changes in dividends that are offset one-for-one by
changes in proceeds from net new issues of securities---so that investment and
earnings are unaffected---do not affect equity valuations. Under conditions, a
related proposition extends the irrelevance result to settings that allow
investment levels to vary as dividends are changed.
Recently these irrelevance propositions have
been questioned by DeAngelo and DeAngelo,
who asserted that dividend payout rules, like investment plans, can be
suboptimal. Therefore, in their view, in general settings there is no valid
irrelevance proposition; low dividend payouts give rise to low valuations. We observe that these assertions can be
sensibly evaluated only in settings that allow bubbles, which were excluded in
the discussions of Miller-Modigliani and DeAngelo-DeAngelo.
As is well known, in standard settings if
bubbles can exist at all, there exists a continuum of equilibrium paths indexed
by initial values of the bubble component of asset values. We show that along
some of these equilibrium paths the Miller-Modigliani dividend irrelevance
result obtains. In other equilibria, however, DeAngelo-DeAngelo's
conclusion that dividend decisions are relevant to equity values is correct.
March 15, 2008
Dividend Policy
and Income Taxation
The effects of dividend and capital gains taxes on optimal dividend
payout policy are analyzed in the context of a one-good model (so that capital
consists of stored units of the consumption good). The aftertax
discount factor is assumed to adjust to taxes to bring about equality between
the discounted value of the firm's aftertax dividend
stream under the optimal dividend policy and the number of units of capital the
firm is operating. A standard result---that the Miller-Modigliani dividend
irrelevance proposition applies in the presence of taxes if the dividend tax
rate equals the capital gains tax rate (and if capital gains are taxed as they
accrue)---is demonstrated. The analysis
is extended to deal with unequal tax rates. The two major results are (1)
allocating retained earnings to share repurchases has the same tax implications
as allocating retained earnings to new investments, and (2) either of these
will be optimal if and only if the tax rate on capital gains is lower than that
on dividends.
JEL codes G1, G3.
May 1, 2008
Present Value
Forthcoming, The New Palgrave Dictionary
of Economics, Second Edition
May 31, 2006
Excess Volatility
Forthcoming, The New Palgrave Dictionary
of Economics, Second Edition
May 31, 2006
Bubbles
and the Intertemporal Government Budget Constraint
Economics Bulletin, 2004
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