Tests of Restrictions and Models in Macro-Finance

Abstract

This dissertation consists of three chapters related to the testing of hypotheses implied by models in macroeconomics and financial economics. Chapter 1, coauthored with Ned Augenblick, develops and implements tests of the assumption of rational expectations in asset markets. We first derive theoretical restrictions on the volatility of asset prices in a general class of rational-expectations equilibria. We then implement these bounds empirically using S&P 500 index option prices and find that these prices are highly volatile. This provides evidence of overreaction to new information relative to rationality, though we discuss possible challenges to this interpretation. In Chapter 2, I consider a similar setting as in Chapter 1 and examine how risk pricing depends on the investment horizon. I show how a certain measure of the price of risk, interpretable as the marginal investor’s effective risk aversion, may be estimated at a given horizon using index option returns. Again using S&P 500 index options data, I find that the price of risk increases substantially as the investment horizon becomes shorter. It is difficult to reconcile this finding with leading asset-pricing models. Chapter 3, coauthored with Daniel J. Lewis and James H. Stock, considers econometric inference in time-series settings. We derive an asymptotic tradeoff between the null rejection rate and power of a given heteroskedasticity- and autocorrelation-robust hypothesis test, which allows us to rank such tests and provide recommendations for empirical practice.