Asset Pricing in the Frequency Domain: Theory and Empirics

Abstract

In many a¢ne asset pricing models, the innovation to the pricing kernel is a function of innovations to current and expected future values of an economic state variable, often consumption growth, aggregate market returns, or short-term interest rates. The impulse response of the priced state variable to various shocks has a frequency (Fourier) decomposition, and we show that the price of risk for a given shock can be represented as a weighted integral over that spectral decomposition. In terms of consumption growth, Epstein-Zin preferences imply that the weight of the pricing kernel lies almost entirely at low frequencies, while internal habit-formation models imply that the weight is shifted to high frequencies. We estimate spectral weighting functions for the equity market semi-parametrically and find that they place most of their weight at low frequencies, consistent with Epstein-Zin preferences. For Treasuries, we find that investors view increases in interest rates at low frequencies and decreases at business-cycle frequencies negatively.

Temperature shocks and welfare costs

“…Differently, under recursive preferences the household cares about uncertainty with respect to future utility and the risk generated by persistent innovations is priced. As a result, long-lasting shocks affect both prices and quantities (see Dew-Becker and Giglio, 2016).…”

Cyclical properties of supply-side and demand-side shocks in oil-based commodity markets

“…The relation gives the shares of forecast error variances in variable i due to shock to variable j. Inspired by similar approaches in the literature, (Stiassny, 1996;Dew-Becker and Giglio, 2016), Baruník and Křehlík (2015) use spectral methods to further investigate the implied unconditional connectedness relations in the frequency domain. The decomposition is achieved by an observation that the spectral behavior of series X t can be described by its frequency response function…”

Asset Pricing with Countercyclical Household Consumption Risk

“…In contrast to the two papers above, the present investigation disentangles the RRA coefficient and the EIS with recursive preferences. The estimated EIS is low and the model is not subject to the criticism of Dew-Becker and Giglio (2016) and Epstein, Farhi, and Strzalecki (2014) on the extreme implications of models with high EIS regarding the preference for early resolution of uncertainty. In addition, the model addresses the level and time-series properties of the risk-free rate, the price-dividend ratio, and the market return, and it also addresses the cross-section of size-, book-to-market equity-, and industrysorted portfolio returns.…”