I am an assistant professor in the finance department of the Wharton School. My research areas are Macroeconomics and Finance, with a particular interest in subjective expectations. Prior to joining Wharton, I was a post-doctoral fellow at the NBER.
Subjective Cash Flow and Discount Rate Expectations Journal of Finance June 2021 with Ricardo De la O (Download Expectations)
Why do stock prices vary? Using survey forecasts, we find that cash flow growth expectations explain most movements in the S&P 500 price-dividend and price-earnings ratios, accounting for at least 93% and 63% of their variation. These expectations comove strongly with price ratios, even when price ratios do not predict future cash flow growth. In comparison, return expectations have low volatility and small comovement with price ratios. Short-term, rather than long-term, expectations account for most price ratio variation. We propose an asset pricing model with beliefs about earnings growth reversal that accurately replicates these cash flow growth expectations and dynamics.
Survey expectations of dividend growth (blue) vary substantially over time and strongly comove with the S&P 500 price-dividend ratio (red). Survey expectations of returns (green) are relatively flat over time and have low comovement with the price-dividend ratio.
Which Subjective Expectations Explain Asset Prices? with Ricardo De la O (February 2023)
Revise and Resubmit at the Review of Financial Studies
We present a method for determining whether errors in expectations explain asset pricing puzzles without imposing assumptions about the mechanism of the error. Using accounting identities and survey forecasts, we find that errors in expected long-term inflation and short-term nominal earnings growth explain price variation, return predictability, and the rejection of the expectations hypothesis for aggregate stock and bond markets. Errors in expected short-term inflation and long-term nominal earnings growth play no role. The relevant errors are consistent with mistakes about both the persistence of forecasted variables and the response to surprises. A fundamental extrapolation model successfully replicates these findings.
Survey expectations of long-term inflation are volatile, moving almost 1-1 with expectations of short-term inflation. In contrast, for survey expectations of S&P 500 nominal earning growth, almost of all of the movements occur in short-term expectations.
The Return of Return Dominance: Decomposing the Cross-Section of Prices with Ricardo De la O and Xiao Han (November 2022)
Are stock valuation ratios mainly informative about future earnings growth or future returns? Using a variance decomposition, we find that over 70% of cross-sectional variation in price-earnings ratios is reflected in cross-sectional differences in future returns, while less than 30% is reflected in cross-sectional differences in future earnings growth. This is because, empirically, valuation ratios primarily predict future returns and only modestly predict future earnings growth. Additionally, changes in predicted future returns are more important than changes in predicted future earnings growth for explaining innovations in price-earnings ratios and current realized returns. We reconcile these results with previous literature which has found a strong relation between prices and future profitability. These results are consistent with models in which the cross-section of stock valuation ratios is driven mainly by discount rates or mispricing rather than differences in future earnings growth.
Cross-sectional differences in stock P/E ratios are mainly explained by expensive stocks having lower future returns and higher future P/E ratios rather than higher future earnings growth. As the horizon increases, the importance of the future P/E ratio declines and is largely replaced by a bigger role for future returns.
Public Employee Pensions and Municipal Insolvency (March 2022)
This paper studies how municipal governments jointly manage spending, credit market borrowing, and public employee pensions. I model governments as levered investors who must meet non-defaultable pension obligations and may value government spending more than citizens. I quantify the model using California city-level data, including a new record of fiscal emergencies, tax increases required to maintain essential services. After the financial crisis depleted pension funds, cities engaged in excessive risk-taking: the fiscal emergency option encouraged gambling for resurrection that kept cities vulnerable to shocks well into the recovery. Restricting risk-taking does not correct this problem, but a spending cap does.
California city governments are highly levered. They issue safe liabilities (bonds and pensions) and invest in risky equity-based pension funds. The most indebted cities (Assets - Total Liabilities) are also the most levered and the most exposed to risky pension funds.
Sovereign Debt, Government Spending Cycles, and Back-loaded Pension Reforms (November 2019)
This paper studies the effect of public pension obligations on a sovereign government's commitment to repaying debt. In the model, the government can renege on its pension promises but suffers a cost from losing the trust of households about future pensions. Large pension promises act as a commitment device for debt because they require the government to have regular access to credit markets. The government's decision to default is driven by its total obligations, not just its debt. Thus, there is a range of pension obligations large enough to act as a commitment device without raising total obligations to the point of default. This otherwise deterministic economy has an endogenous cycle in which periods of high spending and increasing debt are followed by periods of pension reform and debt reduction. The model successfully produces high debt in excess of 100% GDP without default and back-loaded pension cuts that match salient features of recent reforms in six EU nations.
Work in Progress
The Cross-Section of Subjective Expectations: Understanding Prices and Anomalies with Ricardo De la O and Xiao Han (November 2022) (Full draft coming soon!)
Hillenbrand and McCarthy "Heterogeneous Investors and Stock Market Fluctuations" (WFA June 2022)
Carlson, Giammarino, and Heinkel "Municipal Capital Structure" (ASU Winter Conference February 2022)