Essays on asset pricing and financial econometrics

The dissertation is focused on studying the behavior of aggregate asset market and its relationship to real economic activity. Chapter 1 offers a new empirical perspective on the relationship between the conditional mean and volatility of stock returns. Chapter 2 builds a general equilibrium model to analytically analyze the business-cycle behavior of asset returns and identifies its economic sources. On the relationship between the conditional mean and volatility of stock returns: A latent VAR approach. We model the conditional mean and volatility of stock returns as a latent vector autoregressive (VAR) process to study the contemporaneous and intertemporal relationship between expected returns and risk in a flexible statistical framework and without relying on exogenous predictors. We find a strong and robust negative correlation between the innovations to the conditional moments that leads to pronounced counter-cyclical variation in the Sharpe ratio. We document significant lead-lag correlations between the conditional moments that also appear related to business cycles. Finally, we show that although the conditional correlation between the mean and volatility is negative, the unconditional correlation is positive due to the lead-lag correlations. Business-cycle pattern of asset returns: A general equilibrium explanation. In a production economy with over-lapping generations of agents, we develop a tractable general equilibrium model to qualitatively establish and explain economic sources of the business-cycle pattern of stock market returns. In equilibrium, if the capital share of in come is ½ or ⅓, we analytically show that both the expected return and the conditional volatility of asset returns vary counter-cyclically and co-vary positively with the long-term level of productivity. There is a pro-cyclical direct effect and a counter-cyclical indirect effect on asset returns in response to a productivity shock. The indirect effect, which reflects the “feedback” effect of consumers\u27 behavior on asset prices, dominates the direct effect and constitutes the economic source of the counter-cyclical variations of expected returns and conditional volatility. We also show that both the conditional mean and volatility of asset returns are persistent and predictable, and the asset market behavior has forecasting power for real economic activity