How to Discount Cashflows with Time-Varying Expected Returns

While many studies document that the market risk premium is predictable and that betas are not constant, the dividend discount model ignores time‐varying risk premiums and betas. We develop a model to consistently value cashflows with changing risk‐free rates, predictable risk premiums, and conditional betas in the context of a conditional CAPM. Practical valuation is accomplished with an analytic term structure of discount rates, with different discount rates applied to expected cashflows at different horizons. Using constant discount rates can produce large misvaluations, which, in portfolio data, are mostly driven at short horizons by market risk premiums and at long horizons by time variation in risk‐free rates and factor loadings.     

Optimal Hedging in Futures Markets with Multiple Delivery Specifications

Nearly all futures contracts allow delivery of any of several qualities of the underlying asset. Consequently, the price of the futures contract is associated more with the price of the expected cheapest deliverable variety than with the price of the par-delivery variety. The delivery specifications introduce a delivery risk for every hedger in the market. We derive the optimal hedging strategies in these markets. Their hedging effectiveness is evaluated for wheat futures contracts in Chicago. Hedging optimally would have significantly reduced the variance of the rates of return on hedges while yielding similar mean returns.     

The Joy of Giving or Assisted Living? Using Strategic Surveys to Separate Public Care Aversion from Bequest Motives

The “annuity puzzle,” conveying the apparently low interest of retirees in longevity insurance, is central to household finance. Two possible explanations are “public care aversion” (PCA), retiree aversion to simultaneously running out of wealth and being in need of long‐term care, and an intentional bequest motive. To disentangle the relative importance of PCA and bequest motive, we estimate a structural model of the retirement phase using a novel survey instrument that includes hypothetical questions. We identify PCA as very significant and find bequest motives that spread deep into the middle class. Our results highlight potential interest in annuities that make allowance for long‐term care expenses.     

Is the Real Interest Rate Stable?

Univariate time-series models for consumption, nominal interest rates, and prices each appear to have a single unit root before 1979. If nominal interest rates have a unit root but inflation and inflation forecast errors do not, then ex ante real interest rates have a unit root and are therefore nonstationary. This deduction does not depend on the properties of the unobservable ex post observed real return, which combines the ex ante real interest rate and inflation-forecasting errors. The unit-root characteristic of real interest rates is puzzling from at least two perspectives: many models imply that the growth rate of consumption and the real interest rate should have similar time-series characteristics; also, nominal returns for other assets (e.g., stocks and bonds) appear to have different times-series properties from those of treasury bills.     

Federal Deposit Insurance,Regulatory Policy,and Optimal Bank Capital*

This paper seeks to explain the combination of explicit and implicit pricing for deposit insurance employed by the FDIC. Essentially, the FDIC sells two products—insurance and regulation. To span the product space, it must and does set two prices. We argue that the need to establish regulatory disincentives to bank risk-taking is the heart of the controversy over the adequacy of bank capital and that the ability to close risky banks before exhausting their charter value (i.e., the value of their right to continue in business) stands at the center of these disincentives and in front of the FDIC's insurance reserves.     

A Practical Framework for the Analysis of Social Security Reform

‘When I use a word’, Humpty Dumpty said in a rather scornful tone, ‘it means just what I choose it lo mean — neither more nor less’. (Through the Looking Glass, Ch. 6)     

Evidence on the Timing and Determinants of Overfunded Pension Plan Termination

This paper examines the factors associated with the timing of overfunded pension plan termination.     

The Integration of Insurance and Taxes in Corporate Pension Strategy

This paper examines the implications of the joint effects of insurance and taxes for the optimal corporate pension strategy. It is shown that neither the “mini-max” nor the “maxi-min” strategy advocated by previous authors is necessarily best in corporate pension management. In the presence of capital market imperfections, the analysis via a single-period contingent-claims model indicates that optimal corporate pension strategy in both asset-allocation and funding decisions can be a noncorner interior solution.     

Multimarket Trading and Liquidity: Theory and Evidence

We develop a new model of multimarket trading to explain the differences in the foreign share of trading volume of internationally cross‐listed stocks. The model predicts that the trading volume of a cross‐listed stock is proportionally higher on the exchange in which the cross‐listed asset returns have greater correlation with returns of other assets traded on that market. We find robust empirical support for this prediction using stock return and volume data on 251 non‐U.S. stocks cross‐listed on major U.S. exchanges.     

How Do Firms Respond to Political Uncertainty? Evidence from U.S. Gubernatorial Elections

We examine the joint response to political uncertainty along two margins: changes in real activity and voluntary disclosure. We focus on within-firm variation in exposure to ex ante competitive U.S. gubernatorial elections using data on preelection poll margins and firms’ state exposures. Despite real activity falling in the years leading up to a close election, we find that voluntary disclosure increases both in frequency and content, including mentions of risk in filings that reference states holding elections. Our tests use a decomposition of 8-K filings into real activity and voluntary disclosure to address the endogenous complementarity between these two responses. These results hold when using alternative ex ante measures of political uncertainty based on term-limited incumbents, historically competitive offices, or state legislature gridlock. Both effects of political uncertainty are stronger for firms in highly regulated industries and weaker for those least exposed to the local market, linking the real activity and disclosure responses to uncertainty.