UCLA

Forecasts of risk prices at alternative time scales can be used to consolidate history dependence in asset return time series. The resulting Markovian structure identifies a martingale component in the latent transition dynamics. I apply the model to U.S. stock markets and find the concentration of return volatility on the martingale component - the spectral gap - is countercyclical, and predicts annual market returns out-of-sample (o.o.s.) with an R-squared of 10.8%. Value (HML) predictability is concave and front-heavy, peaking at a one-year 14.7% o.o.s. R-squared. In contrast, the momentum predictability term structure is convex, insignificant on the short end, but accelerates to 31.4% o.o.s. R-squared at the three-year horizon. I form timing portfolios to investigate the risk content of the aggregate forecasts. Incremental gains from timing value are compensation for bearing systematic shocks to time-varying expected returns. Exposure to the market timing portfolio is cross-sectionally priced, while gains from timing size (SMB) are not. The findings provide new restrictions for parametric asset pricing theories.

Incomplete human capital markets induce unexpected rebalancing costs that are mitigated by a bank. Ex-ante, the bank exchanges risky endowments for demandable liabilities. An ex-post withdrawal corresponds to exercising a put option on the market, used to resolve an unexpected portfolio choice problem. Portfolio choice opens a risk aversion channel that distinguishes our predictions from Diamond and Dybvig (1983) and related models. In these models, deposits resolve consumption-timing tensions by accommodating the investor's intertemporal elasticity of substitution (IES). The inclusion of risk-based incentives allow us to characterize the endogenous link between the intermediary balance sheet and the preference-based pricing kernel. Moreover, ex-post rebalancing incentives relax enforcement problems for ex-ante optimal policies in incomplete markets. This provides a justification for the coexistence of intermediation and market institutions.