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Essays in macro finance

Bretscher, Lorenzo (2018) Essays in macro finance. PhD thesis, London School of Economics and Political Science.

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Identification Number: 10.21953/lse.ax5fc9n99zzc


In the first paper of my dissertation I document that industries with low offshoring potential have 7.31% higher stock returns per year compared to industries with high offshoring potential, suggesting that the possibility to offshore affects industry risk. This risk premium is concentrated in manufacturing industries that are exposed to foreign import competition. Put differently, the option to offshore effectively serves as insurance against import competition. A two-country general equilibrium dynamic trade model in which firms have the option to offshore rationalizes the return patterns uncovered in the data: industries with low offshoring potential carry a risk premium that is increasing in foreign import penetration. Within the model, the offshoring channel is economically important and lowers industry risk up to one-third. I find that an increase in trade barriers is associated with a drop in asset prices of model firms. The model thus suggests that the loss in benefits from offshoring outweighs the benefits from lower import competition. Importantly, the model prediction that offshorability is negatively correlated with profit volatility is strongly supported by the data. In the second paper (co-authored with Andrea Tamoni and Alex Hsu) we study the impact of fiscal policy shocks on bond risk premia. Government spending level shocks generate positive covariance between marginal utility and inflation (term structure level effect) making nominal bonds a poor hedge against consumption risk leading to positive inflation risk premia. Volatility shocks to spending have strong slope effect (steepening) on the yield curve, producing positive nominal term premia. For level and volatility shocks to capital income tax, term structure level effects dominate, delivering negative risk premia. Fluctuations in term premia are entirely driven by volatility shocks. Lastly, fiscal shocks are amplified at the zero lower bound. The third paper (co-authored with Andrea Tamoni and Alex Hsu) discusses how risk aversion (RA) affects the macroeconomic response to uncertainty shocks. In the data, heightened level of RA during the 2008 crisis amplified the decline of output and investment by roughly 21% and 16%, respectively, at the trough of the recession. The degree of RA determines the impact of second moment shocks in DSGE models featuring stochastic volatility. Ceteris paribus, higher RA leads to stronger responses of macroeconomic variables to uncertainty shocks, making un certainty shocks as economically significant as level shocks. Conversely, elevated RA can amplify or dampen responses to level shocks depending on whether RA exaggerates or attenuates consumption growth expectations.

Item Type: Thesis (PhD)
Additional Information: © 2018 Lorenzo Bretscher
Library of Congress subject classification: H Social Sciences > HG Finance
Sets: Departments > Finance
Supervisor: Julliard, Christian

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