Copyright (c) 2009 All rights reserved. http://works.bepress.com/fatihguvenen Recent documents in Fatih Guvenen en-us Sat, 21 Nov 2009 18:07:15 PST 3600 http://works.bepress.com/fatihguvenen/10 http://works.bepress.com/fatihguvenen/10 Fri, 05 Jun 2009 19:29:36 PDT Asset pricing is a branch of financial economics that is rich in puzzles and anomalies - that is, stylized empirical facts not easily explained by the canonical asset pricing models. These range from the equity premium puzzle and the risk-free rate puzzle to the fact that stock returns are highly predictable. This entry discusses different consumption based asset pricing models that have been developed to resolve these puzzles and it evaluates their empirical performance. Fatih Guvenen http://works.bepress.com/fatihguvenen/9 http://works.bepress.com/fatihguvenen/9 Fri, 05 Jun 2009 19:27:51 PDT The essential element in modern asset pricing theory is a positive random variable called the stochastic discount factor (SDF). This object allows one to price any payoff stream. Its existence is implied by the absence of arbitrage opportunities. Consumption-based asset pricing models link the SDF to the marginal utility growth of investors and in turn to observable economic variables|and in doing so, they provide empirical content to asset pricing theory. This entry discusses this class of models. Fatih Guvenen http://works.bepress.com/fatihguvenen/8 http://works.bepress.com/fatihguvenen/8 Fri, 05 Jun 2009 19:25:17 PDT This paper analyzes the extent of risk-sharing among stockholders and among nonstockholders. Wealthy households play a crucial role in many economic problems due to the substantial concentration of asset holdings in the U.S. data. Hence, to evaluate the empirical importance of market incompleteness, it is essential to determine if idiosyncratic shocks are important for the wealthy, who have access to better insurance opportunities, but also face different risks, than the average household. We study a model where each period households decide whether to participate in the stock market by paying a fixed cost. Due to this endogenous entry decision, the testable implications of perfect risk-sharing take the form of a sample selection model, which we estimate and test using a semi-parametric GMM estimator proposed by Kyriazidou (2001). Using data from PSID we strongly reject perfect risk-sharing among stockholders, but perhaps surprisingly, do not find evidence against it among non-stockholders. These results appear to be robust to several extensions we considered. These findings indicate that market incompleteness may be more important for the wealthy, and suggest further focus on risk factors that primarily affect this group, such as entrepreneurial income risk. Fatih Guvenen http://works.bepress.com/fatihguvenen/7 http://works.bepress.com/fatihguvenen/7 Thu, 28 May 2009 22:07:04 PDT This paper attempts to reconcile two opposing views about the elasticity of intertemporal substitution in consumption (EIS), a parameter that plays a key role in macroeconomic analysis. On the one hand, empirical studies using aggregate consumption data typically find that the EIS is close to zero (Hall, 1988). On the other hand, calibrated macroeconomic models designed to match growth and business cycle facts typically require that the EIS be close to one (Weil, 1989; Lucas, 1990). We show that this apparent contradiction arises from ignoring two kinds of heterogeneity across individuals. First, a large fraction of U.S. households do not participate in stock markets. Second, a variety of microeconomic studies using individual-level data conclude that an individual's EIS increases with his wealth. We study a dynamic macroeconomic model featuring these two realistic sources of heterogeneity which have been largely assumed away in macroeconomics to date. We find that limited participation creates substantial wealth inequality matching that in U.S. data. Consequently, the properties of aggregate variables directly linked to wealth, such as investment and output, are almost entirely determined by the (high-elasticity) stockholders. At the same time, since consumption is much more evenly distributed across households than is wealth, estimation using aggregate consumption uncovers the low EIS of the majority of households (i.e., the poor). Fatih Guvenen http://works.bepress.com/fatihguvenen/6 http://works.bepress.com/fatihguvenen/6 Thu, 28 May 2009 22:05:27 PDT In this paper we reassess the evidence on labor income risk. There are two leading views on the nature of the income process in the current literature. The first view, which we call the Restricted Income Profiles (RIP) process, holds that individuals are subject to large and very persistent shocks, while facing similar life-cycle income profiles. The alternative view, which we call the Heterogeneous Income Profiles (HIP) process, holds that individuals are subject to income shocks with modest persistence, while facing individual-specific income profiles.We first show that ignoring profile heterogeneity, when in fact it is present, introduces an upward bias into the estimates of persistence. Second, we estimate a parsimonious parameterization of the HIP process that is suitable for calibrating economic models. The estimated persistence is about 0.8 in the HIP process compared to about 0.99 in the RIP process. Moreover, the heterogeneity in income profiles is estimated to be substantial, explaining between 56 to 75 percent of income inequality at age 55. We also find that profile heterogeneity is substantially larger among higher educated individuals. Third, we discuss the source of identification - in other words, the aspects of labor income data that allow one to distinguish between the HIP and RIP processes. Finally, we show that the main evidence against profile heterogeneity in the existing literature - that the autocorrelations of income changes are small and negative - is also replicated by the HIP process, suggesting that this evidence may have been misinterpreted. Fatih Guvenen http://works.bepress.com/fatihguvenen/5 http://works.bepress.com/fatihguvenen/5 Thu, 28 May 2009 22:03:53 PDT In this paper we construct a parsimonious overlapping-generations model of human capital accumulation, and study its quantitative implications for the evolution of the U.S. wage distribution from 1970 to 2000. One of the key features of the model is that individuals differ in their ability to accumulate human capital, which is the main source of wage inequality in this model. We examine the response of this model to skill-biased technical change (SBTC), which is modeled as an increase in the trend growth rate of the price of human capital starting in the early 1970's. Due to the heterogeneity in ability and age, the responses of different individuals to SBTC are systematically different from each other, generating rich behavior in the evolution of relative wages. We consider different scenarios regarding how individuals' expectations evolve during SBTC. Specifically, we study the case where individuals immediately realize the advent of SBTC (perfect foresight); and the case where they initially underestimate the future growth of the price of human capital (pessimistic priors), but learn the truth in a Bayesian fashion over time. Lack of perfect foresight appears to have little effect on the main results of the paper. The model is quantitatively consistent with several trends including the rise in overall wage inequality; the fall and rise in the college premium; the rise in within-group inequality; the stagnation in median wage growth, and the small rise in consumption inequality despite the large rise in wage inequality. Overall, the model shows promise for explaining disparate trends in the evolution of the wage distribution in a unifying human capital framework. Fatih Guvenen http://works.bepress.com/fatihguvenen/4 http://works.bepress.com/fatihguvenen/4 Thu, 28 May 2009 22:00:26 PDT In this paper we present an analytically tractable overlapping-generations model of human capital accumulation, and study its implications for the evolution of the U.S. wage distribution from 1970 to 2000. The key feature of the model, and the only source of heterogeneity, is that individuals differ in their ability to accumulate human capital. Therefore, wage inequality results only from differences in human capital accumulation. We examine the response of this model to skill-biased technical change (SBTC) theoretically. We show that in response to SBTC, the model generates behavior consistent with several features of the U.S. data including (i) a rise in overall wage inequality both in the short run and long run, (ii) an initial fall in the education premium followed by a strong recovery, leading to a higher premium in the long run, (iii) the fact that most of this fall and rise takes place among younger workers, (iv) a rise in within-group inequality, (v) stagnation in median wage growth (and a slowdown in aggregate labor productivity), and (vi) a rise in consumption inequality that is much smaller than the rise in wage inequality. These results suggest that the heterogeneity in the ability to accumulate human capital is an important feature for understanding the effects of SBTC, and interpreting the transformation that the U.S. economy has gone through since the 1970's. Fatih Guvenen http://works.bepress.com/fatihguvenen/3 http://works.bepress.com/fatihguvenen/3 Thu, 28 May 2009 21:57:14 PDT Search theory routinely assumes that decisions about the acceptance/rejection of job offers (and, hence, about labor market movements between jobs or across employment states) are made by individuals acting in isolation. In reality, the vast majority of workers are somewhat tied to their partners---in couples and families---and decisions are made jointly. This paper studies, from a theoretical viewpoint, the joint job-search and location problem of a household formed by a couple (e.g., husband and wife) who perfectly pools income. The objective of the exercise, very much in the spirit of standard search theory, is to characterize the reservation wage behavior of the couple and compare it to the single-agent search model in order to understand the ramifications of partnerships for individual labor market outcomes and wage dynamics. We focus on two main cases. First, when couples are risk averse and pool income, joint search yields new opportunities---similar to on-the-job search---relative to the single-agent search. Second, when the two spouses in a couple face job offers from multiple locations and a cost of living apart, joint-search features new frictions and can lead to significantly worse outcomes than single-agent search. Bulent Guler http://works.bepress.com/fatihguvenen/2 http://works.bepress.com/fatihguvenen/2 Thu, 28 May 2009 21:51:34 PDT In this paper, I study asset prices in a two-agent macroeconomic model with two key features: limited participation in the stock market and heterogeneity in the elasticity of intertemporal substitution in consumption (EIS). The model is consistent with some prominent features of asset prices that have been documented in the literature, such as a high equity premium; relatively smooth interest rates; procyclical variation in stock prices; and countercyclical variation in the equity premium, in its volatility, and in the Sharpe ratio. While the model also reproduces the long-horizon predictability of the equity premium, the extent of predictability is smaller than in the data. In this model, the risk-free asset market plays a central role by allowing the non-stockholders (who have low EIS) to smooth the fluctuations in their labor income. This process concentrates non-stockholders' aggregate labor income risk among a small group of stockholders, who then demand a high premium for bearing the aggregate equity risk. Furthermore, this mechanism is consistent with the very small share of aggregate wealth held by non-stockholders in the US data, which has proved problematic for previous models with limited participation. I show that this large wealth inequality is also important for the model's ability to generate a countercyclical equity premium. Finally, when it comes to business cycle performance the model's progress has been more limited: consumption is still too volatile compared to the US data, whereas investment is still too smooth. These are important areas for potential improvement in this framework. Fatih Guvenen http://works.bepress.com/fatihguvenen/1 http://works.bepress.com/fatihguvenen/1 Thu, 28 May 2009 21:48:55 PDT The current literature offers two views on the nature of the labor income process. According to the first view, individuals are subject to very persistent income shocks while facing similar life-cycle income profiles (the RIP process, MaCurdy (1982)). According to the alternative, individuals are subject to shocks with modest persistence while facing individual-specific profiles (the HIP process, Lillard and Weiss, (1979)). In this paper we study the restrictions imposed by these two processes on consumption data--in the context of a life-cycle model-- to distinguish between the two views. We find that the life-cycle model with a HIP process, which has not been studied in the previous literature, is consistent with several features of consumption data, whereas the model with a RIP process is consistent with some, but not with others. We conclude that the HIP model could be a credible contender to--and along some dimensions, a more coherent alternative than--the RIP model. Fatih Guvenen