The challenge of a rising skill premium for redistributive taxation

The present paper analyzes the challenge to redistribution programs posed by an increase in the skill premium. The skill premium affects both the profitability of education and the profitability of migration. We propose a two country, median voter model, where the equilibrium tax policy is shaped by the desire of the median voter to promote skill formation and to avoid emigration of skilled individuals. Our paper shows that the effect of an increase in the skill premium on redistributive programs depends on the initial level of the skill premium. Below a critical level, an increase in the skill premium is met by an increase in the tax rate. Beyond this level, however, a further rise in the skill premium leads to a fall in the tax rate, and hence a sharp increase in post-tax inequality.     

The rising skill premium and deunionization

During the past 50 years, the US economy has seen a rapid decline in labor union membership and a substantial rise in wage inequality. Since labor unions compress wages between skilled and unskilled workers, a rising skill premium encourages skilled workers to withdraw from the union. If this withdrawal is accompanied by a fall in the productivity of unskilled workers, firms become reluctant to hire the relatively expensive union workers, reinforcing the decline in the unionization rate. Evaluating this hypothesis, we find that the rise in the skill premium explains about 40% of the decline in the unionization rate.     

Divergence of US and Local Returns in the After‐market for Equity Issuing ADRs

We study one‐year post‐listing prices and returns to equity issuing ADRs that listed in the US between January 1991 and October 2000. ADRs from countries that impose restrictions on capital flows are priced at a premium to their home market ordinaries. While the mean premium for the full sample is statistically indistinguishable from zero, after an adjustment for asynchronous trading, the magnitude of the premium to ADRs from restricted markets is 11.33% at the 300‐day post listing interval, which is statistically significant. In the short run (30 days) following listing, the magnitude of the premium is larger for ADRs with larger excess demand from US investors. At the longer 300‐day horizon, Nasdaq listed ADRs earn a larger premium than their NYSE/AMEX listed counterparts. Time‐series regressions and two‐stage cross‐sectional regressions establish that the premium to foreign equity issuers is greater if the US listing attracts liquidity and if US returns have a lower correlation with the local country index.     

Crude substitution: The cyclical dynamics of oil prices and the skill premium

At the business cycle frequency, energy prices and the skill premium display a strong, negative correlation. This fact is robust to different de-trending procedures. Identifying exogenous shocks to oil prices using the Hoover-Perez [1994. Post hoc ergo propter once more: an evaluation of ‘Does monetary policy matter?’ in the spirit of James Tobin. Journal of Monetary Econonmics 34, 47-73] dates, shows that the skill premium falls in response to such a shock. The estimation of the parameters of an aggregate technology that uses, among other inputs, energy and heterogeneous skills, demonstrates that capital-skill and capital-energy complementarity are responsible for this correlation. As energy prices rise, the use of capital decreases and the demand for unskilled labor—relative to skilled labor—increases, lowering the skill premium.     

Australian and US interest rate swap markets: comparison and linkages

We investigate and compare the determinants of US and Australian interest rate swap spreads and the linkages between these markets. The slope of the risk‐free term structure is the most significant determinant and its importance is greater for longer terms to maturity. Interest rate levels and, in Australia, the default premium also have some impact. The influences of interest rate volatility, the liquidity premium and (in the USA) the default premium are small or negligible. We hypothesise, and our evidence confirms, that the US swap market significantly affects the Australian swap market but not vice‐versa.     

The Equity Premium: Consistent with GDP Growth and Portfolio Insurance

We find that the long‐term equity premium is consistent with both GDP growth and portfolio insurance. We use a supply‐side growth model and demonstrate that the arithmetic average stock market return and the returns on corporate assets and debt depend on GDP per capita growth. The implied equity premium matches the U.S. historical average over 1926–2001. Separately, we find that the equity premium tracks the value of a put option on the S&P 500. Our theory predicts a smaller equity premium in the future, assuming that the recent regime shifts in dividend policies, interest rates, and tax rates are permanent.     

Student abilities during the expansion of US education

The US experienced two dramatic changes in the structure of education in a 50 year period. The first was a large expansion of educational attainment; the second, an increase in test score gaps between college-bound and non-college-bound students. This paper documents the impact of these two trends on the composition of school groups by ability and the importance of these composition effects for wages. The main finding is that there is a growing gap between the abilities of high school and college-educated workers that accounts for one-half of the college wage premium for recent cohorts and for the entire rise of the college wage premium between the 1910 and 1960 birth cohorts.     

Trade liberalization and the skill premium in developing economies

Empirical evidence shows that while the skill premium narrowed in some developing countries following trade liberalization, it widened in others, or even exhibited non-monotonic behavior. This paper studies a simple dynamic general equilibrium trade model in which differences in initial conditions across developing countries play a key role in explaining the variety of skill premium behaviors. Differences in initial conditions in terms of skilled labor and physical capital emerge in the model due to differences in trade policies. The model can generate non-monotonic behavior for the skill premium following trade liberalization.     

Consumption risk and the cross-section of government bond returns

In this paper we provide a consumption-based explanation of risk in nominal US Treasury bond portfolios. We use a consumption-CAPM with Epstein–Zin–Weil recursive preferences. Our model introduces two sources of risk: uncertainty about current consumption (reflected in contemporaneous consumption growth) and uncertainty about prospects of consumption in a long run (reflected in innovations to expectations about future consumption growth). We use a novel approach to estimate pricing factors in our model: we employ a factor-augmented VAR model with common factors, extracted from a large panel of macroeconomic and financial data, as state variables. We find that the important source of risk in US bonds is related to uncertainty in prospects in future consumption and it induces a positive and significant risk premium. We find as well that covariance risk related to innovations in expectations about future consumption growth is greater for long term bond portfolios than for short term bond portfolios, which is consistent with a duration measure of risk and justifies why long term bonds require greater premium than short term bonds. Our model explains well the cross-sectional variation in average excess returns of bonds with different maturities over the period 1975–2011 and compares favorably with competing models.     

Bidder CEO and Other Executive Compensation in UK M&As

This paper investigates the impact of M&As on bidder (CEO and other) executive compensation employing a unique sample of 100 completed bids in the UK over the 1998–2001 period. Our findings indicate that less independent and larger boards award CEOs significantly higher bonuses and salary following M&A completion both for the full sample and for the UK and US sub‐samples. UK CEOs and executives are rewarded more for the effort exerted in accomplishing intra ‐ industry or large mergers than for diversifying or small mergers and their cash pay is unaffected by other measures of their managerial skill or performance. US bidders are rewarded at higher levels than their UK counterparts and their remuneration is related only to measures of CEO dominance over the board of directors. Overall our findings offer support for the managerial power rather than the agency theory perspective on managerial compensation.     

The risk premium and long-run global imbalances

This study proposes that heterogeneous household portfolio choices within a country and across countries offer an explanation for global imbalances. We construct a stochastic growth multi-country model in which heterogeneous agents face the following restrictions on asset trade. First, the degree of US equity market participation is higher than that of the rest of the world. Second, a fraction of households in each country maintains a fixed share of equity in its portfolios. In our calibrated model, which matches the US net foreign asset position and the equity premium, the average US household loads up more aggregate risk than the average foreign household by investing in risky assets abroad and issuing risk-free assets. As a result, the US is compensated by a high risk premium and runs trade deficits even as a debtor country. The long-run average trade deficit in our model accounts for 50% of the observed US trade deficit.     

Valuation Risk and Asset Pricing

Standard representative‐agent models fail to account for the weak correlation between stock returns and measurable fundamentals, such as consumption and output growth. This failing, which underlies virtually all modern asset pricing puzzles, arises because these models load all uncertainty onto the supply side of the economy. We propose a simple theory of asset pricing in which demand shocks play a central role. These shocks give rise to valuation risk that allows the model to account for key asset pricing moments, such as the equity premium, the bond term premium, and the weak correlation between stock returns and fundamentals.     

Market timing under multiple economic regimes

This article models the US equity premium as a regime‐switching process where the regimes are dependent on economic variables. To characterise the economic regimes, we employ the dimension reduction technique of a principal components analysis to extract business cycle signals from a set of observed macroeconomic variables. We use these conditioning agents to infer the ex ante economic regime. We then test a dynamic asset allocation strategy, which invests in equity and cash on the basis of the predicted regimes. This timing strategy is shown to outperform a simple buy and hold strategy on a risk‐adjusted basis.     

A Generalized Earnings‐Based Stock Valuation Model with Learning

We present a stock valuation model in an incomplete‐information environment in which the unobservable mean of earnings growth rate (MEGR) is learned and price is updated continuously. We calibrate our model to a market portfolio to empirically evaluate its performance. Of the 8.84% total risk premium we estimate, the earnings growth premium is 4.57%, the short‐rate risk contributes 3.38%, and the learning‐induced risk premium on the unknown MEGR is 0.89% (a nontrivial 10% of the total risk premium). This result highlights the significant learning effect on valuation, implying an additional risk premium in an incomplete‐information environment.     

The nature of the foreign listing premium: A cross-country examination

An expanding literature asserts that non-US firms achieve a unique valuation premium for listing on US equity markets. In this paper we test the uniqueness of the US foreign listing premium by examining the premium achieved by foreign listings across a global set of stock exchanges. We highlight that the documented valuation premium for listing on US exchanges is not unique but common to many home and host markets including US firms that list abroad. The cross-sectional variation in the valuation premium appears to have little association with such cross-country institutional features as investor protection rules, law enforcement practice, or accounting disclosure standards. Rather the premium appears most related to variation in pre-listing valuation ratios.     

Has New York become less competitive than London in global markets? Evaluating foreign listing choices over time

We study the determinants and consequences of cross-listings on the New York and London stock exchanges from 1990 to 2005. This investigation enables us to evaluate the relative benefits of New York and London exchange listings and to assess whether these relative benefits have changed over time, perhaps as a result of the passage of the Sarbanes-Oxley Act in 2002. We find that cross-listings have been falling on US exchanges as well as on the Main Market in London. This decline in cross-listings is explained by changes in firm characteristics instead of by changes in the benefits of cross-listing. We show that after controlling for firm characteristics there is no deficit in cross-listing counts on US exchanges related to SOX. Investigating the valuation differential between listed and non-listed firms (the cross-listing premium) from 1990 to 2005, we find that there is a significant premium for US exchange listings every year, that the premium has not fallen significantly in recent years, and that it persists when allowing for time-invariant unobservable firm characteristics. In contrast, no premium exists for listings on London's Main Market in any year. Firms increase their capital-raising activities at home and abroad following a cross-listing on a major US exchange but not following a cross-listing in London. Our evidence is consistent with the theory that an exchange listing in New York has unique governance benefits for foreign firms.     

The long-run equity risk premium

Based on a survey of US Chief Financial Officers (CFOs), we present expectations of the equity risk premium measured over a 10-year horizon relative to a 10-year US Treasury bond. This multi-year survey has been conducted each quarter from June 2000 to June 2005. Each quarter the survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. The individual uncertainty is deduced from the 80% confidence interval that each respondent provides for his or her risk premium assessment. We also present evidence on the determinants of the long-run risk premium. Our analysis suggests there is a positive correlation between the ex ante risk premium and real interest rates as reflected in Treasury Inflation Indexed Notes.     

Long- and short-term interest rates in a risky world

The paper develops and tests a general equilibrium model in which variability, or risk, affects the choice of portfolios. Our measures of variability include only the variability of unanticipated growth in monetary and non-monetary aggregates, and our tests use data ending with the change in Federal Reserve procedures in October 1979. We find that increased variability of unanticipated money growth raises demands for debt and money, and reduces the demand for real capital. Interest rates on both short- and long-term debt rise by a risk premium. We estimate the size of the risk premium before and after the October 1979 change, and we show that the change in Federal Reserve procedures moved the economy to a less efficient point.     

Is the ex‐ante equity risk premium always positive? Evidence from a new conditional expectations model

We model the conditional risk premium by combining principal component analysis and a statistical learning technique, known as boosted regression trees. The method is validated through various out‐of‐sample tests. We apply the estimates to test the positivity restriction on the risk premium and find evidence that the risk premium is negative in periods of low corporate and government bond returns, high inflation and downward‐sloping term structure. These periods are linked with changes in business cycles; the states when theories predict the existence of negative risk premium. Based on the evidence, we reject the conditional capital asset pricing model and raise a question over the practice of imposing the positive risk premium constraint in predictive models.     

Bank Leverage Cycles and the External Finance Premium

By combining the approaches of Gertler and Karadi (2011) (GK) and Bernanke, Gertler, and Gilchrist (1999) (BGG), I develop a Dynamic Stochastic General Equilibrium (DSGE) model with leverage constraints both in the banking and in the nonfinancial firm sector. I calibrate this “full model” to US data. The full model matches the relative volatility of the external finance premium and the procyclicality of bank leverage and thus outperforms both a BGG and a GK‐type model. For a reasonably calibrated combination of balance sheet shocks, the model reproduces a substantial share of the contraction (increase) of investment (the external finance premium) observed during the “Great Recession.”