Countercyclical Income Risk and Portfolio Choices: Evidence from Sweden
with Sylvain Catherine and Paolo Sodini
Revise & Resubmit at the Journal of Finance

Using Swedish administrative panel data, we document that workers facing higher left-tail income risk when equity markets perform poorly are less likely to participate in the stock market and, conditional on participation, have lower equity shares. In line with theory, the relationship between cyclical skewness and stock holdings is proportional to the share of human capital in a worker’s total wealth and vanishes as workers get closer to retirement. Cyclical skewness also predicts portfolio differences within pairs of identical twins. Our findings show that households hedge against correlated tail risks, an important mechanism in asset pricing and portfolio choice models.

Seeking Skewness

Using detailed disaggregated Swedish household administrative data on portfolio holdings and labor income, this paper investigates retail investors’ behavior of seeking skewness in their portfolio choice. I develop a model of rational portfolio choice in which investors optimally hold portfolios with a (positively) skewed return distribution to hedge against (negatively) skewed labor income risk. I find empirical support for the model’s predictions. I find that investors trade off their portfolio’s Sharpe ratio against higher skewness, which explains the suboptimal Sharpe ratio found in previous studies. I also find that skewness seeking is more pronounced for investors with (i) higher overall risk in their labor income, (ii) higher downside risk in their labor income, and (iii) less wealth. Further, I find that investors hold more assets that provide insurance against the time-varying downside risk in their labor income.

Reluctant Entrepreneurs
with Hanming Fang, Ming Li, and Zenan Wu

Using a long history of firm registration and performance data in China, we document that the massive layoff in the State-owned enterprises (SOE) sector has an economically important effect on spurring entrepreneurship. Compared to entrepreneurs in normal times, firms founded by SOE layoff-induced entrepreneurs have better performance. A career choice model illustrates the underlying mechanism, which is that high-skill workers enter into SOE sectors due to their valuation of the non-monetary benefits associated with the SOEs. Overall, the downsizing of the SOE sector increases the reallocation of skills into entrepreneurial activities. Our findings highlight the importance of the SOE sector in shaping the skilled labor force allocation in the economy.

Household Decisions under Pollution-Induced Health Risk
with Hanming Fang and Qian Li

Air pollution has large detrimental effect on human health. Air pollution induced health risk incentivizes households to adjust their life-cycle consumption-saving. Using the Chinese Household Finance Survey data, we study the household consumption-saving behavior in response to the dispersion of air pollution across China. We find that households who face higher levels of air pollution consume less, but increase the proportion of health related consumption. They also make more conservative investment, and exhibit higher demand for insurance. Results hold with pollution instruments using thermal inversions and coal-fired power-plants. These findings are in line with the effects of health risk on households life-cycle decisions. We quantify the welfare cost in a stochastic OLG with endogenous health accumulation under a general equilibrium framework. We show that the air pollution induced health risk and uneven health production technology leads to a welfare loss of nearly 12% in terms of consumption equivalence of newborns.

Multifractal Volatility with Shot-Noise Component
with Laurent Calvet and Jiawen Xu

Empirical evidence shows that volatility jumps upwards due to shocks to uncertainty and then gradually decreases as the uncertainty resolves, a pattern often called the shot-noise effect. In this paper, based on the MSM model in Calvet and Fisher
(2004b), we develop a shot-noise volatility model (SN-MSM) that parsimoniously captures the jump-decay patterns and multifrequency properties of volatility. SN-MSM is obtained by introducing an asymmetric component into the transition matrix of a Markov-switching multifractal (MSM). SN-MSM generates extreme jumps and volatility decay patterns while preserving the fat tails and volatility clustering of MSM. We derive the closed-form likelihood function of our process and verify that maximum likelihood estimation produces accurate parameter estimates in Monte Carlo simulation. In an empirical application to five major currency series, the SN-MSM model exhibits superior performance than popular volatility models both in- and out-of-sample.

ETF Dividend Cycles
with Pekka Honkanen and Tong Zhou

Exchange-traded funds (ETFs) collect approximately 7% of all U.S. corporate dividends, which they are required to redistribute to investors. How do the funds manage these dividend flows, and does such management have spillover effects on other financial markets? In this paper, we document a new stylized fact of the “ETF dividend cycle:” ETFs gradually invest in money market funds (MMFs) when they accumulate dividend receipts and periodically withdraw from MMFs when they distribute dividends. This cycle creates periodic liquidity shocks to MMFs and, consequently, to the Treasury markets as the affected MMFs liquidate some of their short-term Treasury holdings to satisfy ETFs’ dividend-driven withdrawals. As a result, ETF dividend cycles can explain flows to MMFs and fluctuations in Treasury yields.