This paper evaluates skewness in the cross-section of stock returns in light of predictions from a well-known class of models. Cross-sectional skewness in monthly returns far exceeds what the standard lognormal model of returns would predict. However, skewness in long-run returns substantially...

Large crises tend to follow rapid credit expansions. Causality, however, is far from obvious. We show how this pattern arises naturally when financial intermediaries optimally exploit economic rents that drive their franchise value. As this franchise value fluctuates over the business cycle, so...

What is the connection between financing constraints and the equity premium? To answer this question, we build a model with inalienable human capital, in which investors finance individuals who can potentially become skilled. Though investment in skill is always optimal, it does not take place...

We consider an economy in which investors believe dividend growth is predictable, when in reality it is not. We show that these beliefs lead to excess volatility and return predictability. We also show that these beliefs are rational in the face of evidence on dividend growth. We apply this...

Studies of human memory indicate that features of an event evoke memories of prior associated contextual states, which in turn become associated with the current event's features. This mechanism allows the remote past to influence the present, even as agents gradually update their beliefs about...

We examine the evidence on excess stock return predictability in a Bayesian setting in which the investor faces uncertainty about both the existence and strength of predictability. When we apply our methods to the dividend-price ratio, we find that even investors who are quite skeptical about...

Many applications in financial economics use data series with different starting or ending dates. This paper describes estimation methods, based on the generalized method of moments (GMM), which make use of all available data for each moment condition. We introduce two asymptotically equivalent...

This review article describes recent literature on asset allocation, covering both static and dynamic models. The article focuses on the bond--stock decision and on the implications of return predictability. In the static setting, investors are assumed to be Bayesian, and the role of various...

Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time-varying probability of a consumption disaster. In the model, aggregate consumption follows a...

Habit utility has been the focus of a large and growing body of literature in financial economics. This study investigates ways of accurately and efficiently solving the Campbell and Cochrane (1999) external habit model. Solutions for this model based on a grid of values for the state variable...