Abstract: Investors can choose to hold diversified or levered, concentrated portfolios of risky assets. This paper studies the dynamics of asset prices in an economy in which both investment styles coexist in equilibrium even though all agents are ex-ante identical. 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 for the productivity gains they bring to the corresponding enterprises. I show that fluctuations in the quantity of active capital increase the volatility of asset prices relative to a standard economy. Not all shocks shift the distribution of ownership: risk considerations determine the willingness to provide active capital, whereas current and expected future economic activity do not play a role. Therefore, 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 times, a large number of concentrated owners are likely to exit their positions and sell off their assets.
Revised 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?