The Journal of Finance

Innovation, Growth, and Asset Prices

Published: 5/11/2015,  Volume: 70,  Issue: 3  |  DOI: 10.1111/jofi.12241  |  Cited by: 280

HOWARD KUNG, LUKAS SCHMID

We examine the asset pricing implications of a production economy whose long‐term growth prospects are endogenously determined by innovation and R&D. In equilibrium, R&D endogenously drives a small, persistent component in productivity that generates long‐run uncertainty about economic growth. With recursive preferences, households fear that persistent downturns in economic growth are accompanied by low asset valuations and command high‐risk premia in asset markets. Empirically, we find substantial evidence for innovation‐driven low‐frequency movements in aggregate growth rates and asset market valuations. In short, equilibrium growth is risky.

Levered Returns

Published: 3/19/2010,  Volume: 65,  Issue: 2  |  DOI: 10.1111/j.1540-6261.2009.01541.x  |  Cited by: 239

JOAO F. GOMES, LUKAS SCHMID

This paper revisits the theoretical relation between financial leverage and stock returns in a dynamic world where both corporate investment and financing decisions are endogenous. We find that the link between leverage and stock returns is more complex than static textbook examples suggest, and depends on the investment opportunities available to the firm. In the presence of financial market imperfections, leverage and investment are generally correlated so that highly levered firms are also mature firms with relatively more (safe) book assets and fewer (risky) growth opportunities. A quantitative version of our model matches several stylized facts about leverage and returns.

Investment‐Based Corporate Bond Pricing

Published: 11/10/2014,  Volume: 69,  Issue: 6  |  DOI: 10.1111/jofi.12204  |  Cited by: 113

LARS‐ALEXANDER KUEHN, LUKAS SCHMID

A standard assumption of structural models of default is that firms' assets evolve exogenously. In this paper, we examine the importance of accounting for investment options in models of credit risk. In the presence of financing and investment frictions, firm‐level variables that proxy for asset composition are significant determinants of credit spreads beyond leverage and asset volatility, because they capture the systematic risk of firms' assets. Cross‐sectional studies of credit spreads that fail to control for the interdependence of leverage and investment decisions are unlikely to be very informative. Such frictions also give rise to a realistic term structure of credit spreads in a production economy.

Equilibrium Asset Pricing with Leverage and Default

Published: 11/23/2020,  Volume: 76,  Issue: 2  |  DOI: 10.1111/jofi.12987  |  Cited by: 67

JOÃO F. GOMES, LUKAS SCHMID

We develop a general equilibrium model linking the pricing of stocks and corporate bonds to endogenous movements in corporate leverage and aggregate volatility. The model features heterogeneous firms making optimal investment and financing decisions and connects fluctuations in macroeconomic quantities and asset prices to movements in the cross section of firms. Empirically plausible movements in leverage produce realistic asset return dynamics. Countercyclical leverage drives predictable variation in risk premia, and debt‐financed growth generates a high value premium. Endogenous default produces countercyclical aggregate volatility and credit spread movements that are propagated to the real economy through their effects on investment and output.

A Macrofinance View of U.S. Sovereign CDS Premiums

Published: 6/9/2020,  Volume: 75,  Issue: 5  |  DOI: 10.1111/jofi.12948  |  Cited by: 63

MIKHAIL CHERNOV, LUKAS SCHMID, ANDRES SCHNEIDER

Premiums on U.S. sovereign credit default swaps (CDS) have risen to persistently elevated levels since the financial crisis. We examine whether these premiums reflect the probability of a fiscal default—a state in which a balanced budget can no longer be restored by raising taxes or eroding the real value of debt by increasing inflation. We develop an equilibrium macrofinance model in which the fiscal and monetary policy stances jointly endogenously determine nominal debt, taxes, inflation, and growth. We show that the CDS premiums reflect the endogenous risk‐adjusted probabilities of fiscal default. The calibrated model is consistent with elevated levels of CDS premiums but leaves dynamic implications quantitatively unresolved.

The Term Structure of Covered Interest Rate Parity Violations

Published: 3/31/2024,  Volume: 79,  Issue: 3  |  DOI: 10.1111/jofi.13336  |  Cited by: 19

PATRICK AUGUSTIN, MIKHAIL CHERNOV, LUKAS SCHMID, DONGHO SONG

We quantify the impact of risk‐based and nonrisk‐based intermediary constraints (IC) on the term structure of covered interest rate parity (CIP) violations. Using a stochastic discount factor (SDF) inferred from interest rate swaps, we value currency derivatives. The wedge between model‐implied and observed derivative prices reflects the impact of nonrisk‐based IC because our SDF incorporates risk‐based IC. There is no wedge at short horizons, while the wedge accounts for 40% of long‐term CIP violations. Consistent with IC theory, the wedge correlates with the shadow cost of intermediary capital, and the SDF‐implied interest rate is a weighted average of collateralized and uncollateralized interest rates.

Climate Change, Demand Uncertainty, and Firms' Investments: Evidence from Planned Power Plants

Published: 7/23/2026,  Volume: ,  Issue:   |  DOI: 10.1111/jofi.70071  |  Cited by: 0

CHEN LIN, THOMAS SCHMID, MICHAEL S. WEISBACH

How does demand uncertainty affect firms' investment decisions? We examine this question in the context of electricity‐producing firms' planned investments in new power plants. We measure uncertainty about future electricity demand using plausibly exogenous variation in temperature projections across scientific climate models. The results show that uncertainty increases investment in power plants with flexible production technologies, while reducing investment in less flexible technologies. Overall, the net effect of uncertainty on investment is positive when firms have access to flexible investment opportunities. These findings are consistent with models in which production flexibility shapes the investment response to demand uncertainty.

Information Flows in Foreign Exchange Markets: Dissecting Customer Currency Trades

Published: 3/18/2016,  Volume: 71,  Issue: 2  |  DOI: 10.1111/jofi.12378  |  Cited by: 102

LUKAS MENKHOFF, LUCIO SARNO, MAIK SCHMELING, ANDREAS SCHRIMPF

We study the information in order flows in the world's largest over‐the‐counter market, the foreign exchange (FX) market. The analysis draws on a data set covering a broad cross‐section of currencies and different customer segments of FX end‐users. The results suggest that order flows are highly informative about future exchange rates and provide significant economic value. We also find that different customer groups can share risk with each other effectively through the intermediation of a large dealer, and differ markedly in their predictive ability, trading styles, and risk exposure.

Carry Trades and Global Foreign Exchange Volatility

Published: 3/27/2012,  Volume: 67,  Issue: 2  |  DOI: 10.1111/j.1540-6261.2012.01728.x  |  Cited by: 739

LUKAS MENKHOFF, LUCIO SARNO, MAIK SCHMELING, ANDREAS SCHRIMPF

We investigate the relation between global foreign exchange (FX) volatility risk and the cross section of excess returns arising from popular strategies that borrow in low interest rate currencies and invest in high interest rate currencies, so‐called “carry trades.” We find that high interest rate currencies are negatively related to innovations in global FX volatility, and thus deliver low returns in times of unexpected high volatility, when low interest rate currencies provide a hedge by yielding positive returns. Furthermore, we show that volatility risk dominates liquidity risk and our volatility risk proxy also performs well for pricing returns of other portfolios.

Long‐Horizon Exchange Rate Expectations

Published: 9/29/2025,  Volume: 80,  Issue: 6  |  DOI: 10.1111/jofi.13504  |  Cited by: 11

LUKAS KREMENS, IAN W. R. MARTIN, LILIANA VARELA

We study exchange rate expectations in surveys of financial professionals and find that they successfully forecast currency appreciation at the two‐year horizon, both in and out of sample. Exchange rate expectations are also interpretable, in the sense that three macro‐finance variables—the risk‐neutral covariance between the exchange rate and equity market, the real exchange rate, and the current account relative to GDP—explain most of their variation. There is no “secret sauce,” however, in expectations: After controlling for the three macro‐finance variables, the residual information in survey expectations does not forecast currency appreciation in our sample.