Working Papers

I use Gabaix and Koijen (2021) to construct a Granular Instrumental Variable based on idiosyncratic flows from different investment sectors as an instrument for aggregate stock market returns. I use these instrumented returns to investigate the impact of stock market returns on the real economy. I find that stock market returns have a large impact on aggregate GDP, consumption and investment growth, primarily, but not only, through Durable Consumption and Residential Investment. Motivated by the results of Hartzmark and Solomon (2022), I use high- and low- dividend payment day returns, aggregated to the quarterly level, as an alternative identification strategy and find an almost identical impact of stock returns on GDP growth.

We study an endowment economy with heterogeneous agents and two complementary consumption goods, one of which is indivisible. Although agents have standard log-CES preferences, the indivisibility gives rise to Friedman-Savage convexity in indirect utility. Agents care about relative, not just absolute, wealth, as well as rankings. While agents dislike small risks, they like large ones. Poorer agents exhibit a preference for lottery-like assets with negative expected returns and also invest a smaller share of wealth than richer agents in assets with positive expected returns. If the difference in wealth is large, poor agents play a lottery among themselves with a single winner. In consequence, richer agents have a higher expected return on wealth and inequality is expected to increase. While initial inequality affects investment choices, it has only a minor effect on ultimate inequality. Therefore, standard prescriptions for reducing inequality may have little effect.

We develop a mean-variance model of capital market equilibrium with heterogeneous beliefs. When investors disagree about future asset prices, optimists and pessimists would borrow cash and assets, respectively, from each other, to take positions in line with their beliefs. Borrowing contracts are collateralized by borrowers’ wealth. However, due to disagreement, lenders do not value the collateral as much as their borrowing counterparts do, thus become reluctant to lend. This limits the borrowing capacities of investors, which endogenously generate leverage constraint and short-sales constraint. Under the consensus belief, we derive a modified CAPM that incorporates the shadow prices of two borrowing constraints, which appear with opposite signs. With either very low or very high disagreement, the standard CAPM holds because both constraints either do not bind or bind to a similarly large degree. When disagreement is moderate, leverage constraint is generally tighter than short-sales constraint. Consequently, less risky assets will be underpriced relative to the standard CAPM, while riskier assets will be overpriced. We confirm our theoretical predictions using the daily trading volume in the stock market as our measure of disagreement.

Other Publications in Physics and Maths