Abstract: I study the dynamics of asset prices in an economy in which investors choose whether to hold diversified or concentrated portfolios of risky assets. The latter are valuable, as they increase the productivity of the corresponding enterprises. I capture the tradeoff between risk sharing and productivity gains by introducing what I call "active capital": people who participate in such investments are restricted in their outside opportunities but receive extra compensation. In equilibrium, active and standard capital coexist. The willingness to provide active capital is mainly determined by risk considerations. Therefore, the quantity of active capital fluctuates jointly with risk premia, amplifying their variations. As a consequence, the price of volatility risk exposure can be large and return volatility is mainly induced by fluctuations in future expected returns. These results are particularly strong when fundamental volatility is low, because at such time, a large number of concentrated owners are likely to exit their positions and sell off their assets.
New version 03/13; Supplementary appendix
Abstract: We argue buyout waves form in response to fluctuations in aggregate discount rates. In our model, discount rates alter the present value of cash-flow improvements and the illiquidity premium demanded by buyout investors. We empirically confirm our predictions. Overall deal activity varies positively with the risk premium and negatively with the risk-free rate, with heterogeneous effects across firms. Cross-sectionally, firms with high systematic or idiosyncratic risk are less likely targets. We structurally decompose variation in activity between changes in the value of cash flow and the illiquidity premium. The positive correlation of the two explains the wave behavior of activity.
When Ignorance is Bliss: Endogenous Attention to Signals under Disappointment Aversion (with Marianne Andries)
Changing Risk: Volatility or Persistence?