Christian Julliard - Research

Papers in Refereed Journals

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

We study a broad class of asset pricing models in which the stochastic discount factor (SDF) can be factorized into an observable component and a potentially unobservable, model-specific, one. Exploiting this decomposition we derive new entropy bounds that restrict the admissible regions for the SDF and its components. Without using this decomposition, to a second order approximation, entropy bounds are equivalent to the canonical Hansen-Jagannathan bounds. However, bounds based on our decomposition have higher information content, are tighter, and exploit the restriction that the SDF is a positive random variable. Our information-theoretic framework also enables us to extract a non-parametric estimate of the unobservable component of the SDF. Empirically, we find it to have a business cycle pattern, and significant correlations with both financial market crashes unrelated to economy-wide contractions, and the Fama-French factors. We apply our methodology to some leading consumption-based models, gaining new insights about their empirical performance.

2. Human Capital and International Portfolio Diversification: A Reappraisal with L. Bretscher and C. Rosa , forthcoming, Journal of International Economics

We study the implications of human capital hedging for international portfolio choice. First, we document that, at the household level, the degree of home country bias in equity holdings is increasing in the labor income to financial wealth ratio. We show that a heterogeneous agent model in which households face short selling constraints and labor income risk, calibrated to match both micro and macro labor income and asset returns data, can both rationalize this finding and generate a large aggregate home country bias in portfolio holdings. Second, we find that the empirical evidence supporting the belief that the human capital hedging motive should skew domestic portfolios toward foreign assets, is driven by an econometric misspecification rejected by the data. Third, we show that, given the high degree of international GDP correlations in the data, very small domestic redistributive shocks are sufficient to skew portfolios toward domestic assets.

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.”

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

Probably not. 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. 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.

5. 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.

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.

Working Papers

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

We develop a tractable model in which trade is generated by asymmetry in agents' information sets. We show that, even if news are not generated by a stochastic volatility process, in the presence of information treatment and/or order processing costs, the (unique) equilibrium price process is characterised by stochastic volatility. The intuition behind this result is simple. In the presence of trading costs and dynamic information, agents strategically chose their trading times. Since new information is released to the market only at trading times, the price process sampled at trading times is not characterised by stochastic volatility. But since trading and calendar times differ, the price process at calendar times is the time change of the price process at trading times -- i.e. price movements on the calendar time scale are characterised by stochastic volatility. Our closed form solutions imply that: i) volatility is autocorrelated and is a non-linear function of both number and volume of trades; ii) the relative informativeness of numbers and volume of trades depends on the sampling frequency of the data; iii) volatility, the limit order book, and liquidity, in terms of tightness, depth, and resilience, are jointly determined by information asymmetries and trading costs. The model is able to rationalise a large set of empirical evidence about stock market volatility, liquidity, limit order books, and market frictions, and provides a natural laboratory for analysing the equilibrium effects of a financial transaction tax.
Internet Appendix

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

Slides and the interbank network daily liquidity flows movie

We model banks’ liquidity holding decision as a simultaneous game on an interbank borrowing network. We show that at the Nash equilibrium, the contributions of each bank to the network liquidity level and liquidity risk are distinct functions of its indegree and outdegree Katz-Bonacich centrality measures. A wedge between the planner and the market equilibria arises because individual banks do not internalize the effect of their liquidity choice on other banks’ liquidity benefit and risk exposure. The network can act as an absorbent or a multiplier of individual banks’ shocks. Using a sterling interbank network database from January 2006 to September 2010, we estimate the model in a spatial error framework, and find evidence for a substantial, and time varying, network risk: in the period before the Lehman crisis, the network is cohesive and liquidity holding decisions are complementary and there is a large network liquidity multiplier; during the 2007-08 crisis, the network becomes less clustered and liquidity holding less dependent on the network; after the crisis, during Quantitative Easing, the network liquidity multiplier becomes negative, implying a lower network potential for generating liquidity. The network impulse-response functions indicate that the risk key players during these periods vary, and are not necessarily the largest borrowers.

3. The International Diversification Puzzle is not Worse Than You Think with C. Rosa

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.

4. Labor Income Risk and Asset Returns

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.

5. Human Capital and International Portfolio Choice

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.