Christian Julliard - Research

Papers in Refereed Journals

1. Consumption Risk and the Cross-Section of Expected Returns, with J. Parker, Journal of Political Economy, 113(1), February 2005.

While contemporaneous consumption risk explains little of the variation in average returns across risky assets, our measure of ultimate consumption risk at a horizon of three years explains a large fraction of this variation.

2. Money Illusion and Housing Frenzies, with M. Brunnermeier, The Review of Financial Studies, 21(1), 2008.

The confusion between changes in nominal and real interest rates boosts real house prices when inflation declines.

Media Mentions: 24/08/2007, Science Magazine; 10/02/05, New York Time.

3. Can Rare Events Explain the Equity Premium Puzzle?, with A. Ghosh, The Review of Financial Studies, 25(10), 2012.

Two centuries of international consumption and asset returns data do not provide any empirical support for the rare disasters explanation of the puzzle. The opposite conclusion, presented in the previous literature, is due to counterfactual calibrations.

4. Human Capital and International Portfolio Diversification: A Reappraisal, with L. Bretscher and C. Rosa Journal of International Economics, 99(S1), 2016.

At the household level, the portfolio home country bias in increasing in the labor income to financial wealth ratio. Both aggregate and household level home bias are explained by liquidity constraint and labor income risk. Previous empirical results are driven by an econometric misspecification rejected by the data.

Note: This paper is based upon, and replaces, two companion papers: “The International Diversification Puzzle is not Worse Than You Think” and “Human Capital and International Portfolio Choice.”

5. What is the Consumption-CAPM missing? An Information-Theoretic Framework for the Analysis of Asset Pricing Models, with A. Ghosh and A. Taylor, The Review of Financial Studies, 2016.

For SDFs that can be factorized into an observable component and a potentially unobservable one: a) we derive novel entropy bounds; b) we provide a non-parametric MLE of the SDF and its components. Commonly used consumption-based SDFs: correlate poorly with the estimated one; require high risk aversion to satisfy the bounds; understate market crash risk.

Working Papers

1. An Information-Theoretic Asset Pricing Model, with A. Ghosh and A. Taylor

Given a set of asset returns, an information-theoretic approach is used to estimate non-parametrically the pricing kernel to price the given cross-section out-of-sample. Compared to leading factor models, this information SDF delivers smaller pricing errors and better cross-sectional fit, and identifies the maximum Sharpe ratio portfolio out-of-sample. Moreover, it extracts novel pricing information not captured by Fama-French and momentum factors, leading to an “information anomaly.” A tradable information portfolio that mimics this kernel has very high out-of-sample Sharpe ratio, outperforming both the 1/N benchmark and the Value and Momentum strategies combined. These results hold for a wide cross-section of assets.

2. Information Asymmetries, Volatility, Liquidity, and the Tobin Tax, with A. Danilova

Information asymmetries and trading costs, in a financial market model with dynamic information, generate a self-exciting equilibrium price process with stochastic volatility, even if news have constant volatility. Intuitively, new (constant volatility) information is released to the market at trading times that, due to traders’ strategic choices, differ from calendar times. This generates an endogenous stochastic time change between trading and calendar times, and stochastic volatility of the price process in calendar time. In equilibrium: price volatility is autocorrelated and is a non-linear function of number and volume of trades; the relative informativeness of number and volume of trades depends on the data sampling frequency; volatility, price quotes, tightness, depth, resilience, and trading activity, are jointly determined by information asymmetries and trading costs. Our closed form solutions rationalize a large set of empirical evidence and provide a natural laboratory for analyzing the equilibrium effects of a financial transaction tax.

Internet Appendix

3. Network Risk and Key Players: A Structural Analysis of Interbank Liquidity, with E. Denbee, Y. Li, and K. Yuan

We estimate the liquidity multiplier and study systemic liquidity risk using a network model of the interbank market. Banks’ daily liquidity holding decisions are modelled as a game on a borrowing and lending network. At the Nash equilibrium, each bank’s contributions to the network liquidity level and risk are distinct functions of its indegree and outdegree Katz–Bonacich centrality measures, and the network can damp or amplify the shocks to individual banks. Using a sterling interbank database we structurally estimate the model and find a substantial, and time varying, network generated risk: before the Lehman crisis, the network was cohesive, liquidity holding decisions were complementary, and there was a large network liquidity multiplier; during the 2007–08 crisis, the network became less clustered and liquidity holding less dependent on the network; during Quantitative Easing, the network liquidity multiplier became negative, implying a lower potential for the network to generate liquidity.

Winner of Fondation Banque de France Research Grant, 2012

The interbank network daily liquidity flows movie

4. The Consumption Risk of Bonds and Stocks, with S. Bryzgalova

Aggregate consumption growth reacts slowly, but significantly, to bond and stock return innovations. As a consequence, slow consumption adjustment (SCA) risk, measured by the reaction of consumption growth cumulated over many quarters following a return, can explain most of the cross-sectional variation of expected bond and stock returns. Moreover, SCA shocks explain about a quarter of the time series variation of consumption growth, a large part of the time series variation of stock returns, and a significant (but small) fraction of the time series variation of bond returns, and have substantial predictive power for future consumption growth.

Winner of Oustanding Paper Award in Investment, Midwest Finance Association, 2016

Work in Progress (coming soon)

1. The Market Cost of Business Cycle Fluctuations, with A. Ghosh

We propose a novel measure of the cost of consumption fluctuations that does not require taking a stand on neither the specification of preferences nor the dynamic structure of the economy. Using data on consumption and asset prices, we use an information-theoretic approach to estimate the pricing kernel in a model-free setting. The estimated kernel – that has the interpretation being a non-parametric maximum likelihood estimate – accurately prices broad cross-sections of assets and exhibits substantial skewness, the latter suggesting that tail risk is an important of priced risk. The kernel implies that the cost of all consumption fluctuations in consumption is an order of magnitude higher than what has been argued in the literature. Moreover, contrary to earlier literature, the cost of business cycle fluctuations constitutes a substantial proportion of the cost of all consumption fluctuations. The difference in results from earlier literature can be attributed to the pricing ability of the estimated kernel and its non-Gaussian distribution.

2. The UK Repo Market and the Haircut Determinants, with K. Yuan, Z. Liu, and S. E. Seyedan

We analyse the structure of the UK repo market using a regulatory dataset that covers about 70% of this market. We examine the maturity structure, collateral types and different counterparty types that engage in this market and try to estimate the extent of collateral rehypothecation by the banks. We try to address the question of what variables determine haircuts using transaction-level data. We find that collateral rating and transaction maturity have first order importance in setting haircuts. Hedge funds, as borrowers, receive a significantly higher haircut even after controlling for measures of counterparty risk. We find that larger borrowers with higher ratings receive lower haircuts, but this effect can be overshadowed by collateral quality, because weaker borrowers try to use higher quality collateral to receive a lower haircut. Lender characteristics appear to matter for haircuts, but the results are less stable. Finally we examine the structure and attributes of the repo market network and assess if the network structure has an influence over haircuts. We do not find a significant effect in that respect.

3. Speculative Trading and Derivative Market Imbalances, with A. Danilova and Y. Stoev

We consider an economy in which some agents do not continuously hedge their position in derivative assets using the underlying assets market – i.e. we study the effects of an imbalanced derivate market. We show that, even in the presence of complete markets, the imbalance significantly alters the equilibrium price process of the underlying assets: risk premia and volatility become stochastically time varying, hence option implied volatility is characterized by smile and smirk patterns, momentum-like price dynamics arise as well as price spillovers across underlying assets. Moreover, the derivative imbalance generates self-fulfilling equilibria, e.g. if the imbalance takes the form of a bet on an increase in asset volatility, then the equilibrium volatility does increase. Finally, since our formulation is extremely general, our results also apply to segmented markets where some investments are achievable only via financial intermediation.

Book Chapters

1. La diversificazione del portafoglio delle famiglie italiane, with T. Jappelli and M. Pagano, in XIX Rapporto sul Risparmio e sui Risparmiatori in Italia, A. Beltratti ed., BNL/Centro Einaudi, 2001, pp.91-121. (in Italian)
Updated English version: Households’ Portfolio Diversification, CSEF Working Paper No. 180, June 2007.

Most households’ portfolios are extremely close to the efficient frontier once we explicitly take into account no short-selling constraints, while the null hypothesis of efficiency is rejected for all portfolios if we don’t consider these constraints.

Older Working Papers

1. The International Diversification Puzzle is Not Worse Than You Think. Published as: Human Capital and International Portfolio Diversification: A Reappraisal

We study the implications of human capital hedging for international portfolio diversification. First, we show that given the degree of international economic integration observed in the data, very small domestic redistributive shocks can lead to home country bias in portfolio holdings. Second, we find that the seminal empirical result of Baxter and Jermann (1997) – that the international diversification puzzle is worsened if we consider the human capital hedging motive – is driven by an econometric misspecification that restricts the countries considered in their study to be economically not integrated. Moreover, once this misspecification is corrected, considering the human capital risk does not unequivocally worsen the puzzle, and in some cases helps explaining it. Third, we document that the substantial statistical uncertainty on measuring returns to the aggregate capital stock can rationalize the disagreements in the previous literature. Fourth, we find sharp evidence that if the set of assets that can be used to hedge aggregate human capital is restricted to publicly traded stocks, the human capital hedging motive has a negligible impact on optimal portfolio choice. This last finding is driven by the extremely small correlation between stock market returns and returns to human capital.

2. Human Capital and International Portfolio Choice. Published as: Human Capital and International Portfolio Diversification: A Reappraisal

This paper shows that in a non-representative agent model in which households face short selling constraints and labor income risk, in the form of both uninsurable shocks and a common aggregate component, small differences in the correlation between aggregate labor income shocks and domestic and foreign stock market returns lead to a very large home bias in asset holdings. Calibrating this buffer-stock saving model to match both microeconomic and macroeconomic U.S. labor income data, I demonstrate that, consistent with the empirical literature, a) investors that enter the stock market will initially specialize in domestic assets, b) individual portfolios become more internationally diversified, adding foreign stocks one at a time, as the level of asset wealth increases, and c) most importantly, the implied aggregate portfolio of U.S. investors shows a large degree of home bias consistent with observed levels.

3. Labor Income Risk and Asset Returns (under revision)

This paper shows, from the consumer’s budget constraint, that expected future labor income growth rates and the residuals of the cointegration relation among log consumption, log asset wealth and log current labor income (summarized by the variable cay of Lettau and Ludvigson (2001a, 2001b)), should help predict U.S. quarterly stock market returns and explain the cross-section of average returns. I find that a) fluctuations in expected future labor income are a strong predictor of both real stock returns and excess returns over a Treasury bill rate, b) when this variable is used as conditioning information for the Consumption Capital Asset Pricing Model (CCAPM), the resulting linear factor model explains a large fraction of the variation in observed average returns across the Fama and French (25) portfolios and prices correctly the small growth portfolio. The paper also finds that about one third of the variance of returns is predictable, over a horizon of one year, using expected future labor income growth rates and cay jointly as forecasting variables.