Every summer, Stanford University hosts a series of workshop sessions in economic theory and its applications, a program known as the Stanford Institute for Theoretical Economics (SITE). The purpose of SITE is to advance economic science for the benefit of society and to support cutting-edge work in economics.
Due to the Covid-19 pandemic, this year’s workshop sessions will be held entire online via Zoom and are open to the public.
Karl Schmedders, IMD Professor of Finance, co-hosts a workshop on “Asset Pricing, Macro Finance and Computation” from July 15–17. While the workshop is primarily aimed at researchers in economics and finance, the presented works offer a variety of important insights to executives, public policy makers, and private investors.
Macro Finance studies the relationship between asset prices, such as stock and bond prices, and fluctuations in the economy, such as variations in household consumption and firm production. This subfield of economics and finance is based on some simple observations from business cycles (the ups and downs of economic growth) and from financial markets and it attempts to understand the link between them. Insights from macro finance are of interest to economic policy makers, to businesses, and to households making savings and investment decisions.
To illustrate the kind of questions research in macro finance tries to answer, let us consider the following observation: stocks have substantially higher average returns than bonds. These excess returns or “risk premia” clearly reflect the higher risk inherent in stocks. But research in macro finance has shown that this explanation alone does not justify the magnitude of risk premia. Instead, the risk in stocks has additional special features. Stock values often fall at very inconvenient times, namely they do badly in bad economic times. So, in times when people may lose their jobs or dot not receive a promotion, they also face losses in their stock investments. And it is this particular correlation between economic growth and stock performance that adds substantially to risk premia.
While macro finance has shed light on many issues relating to the interplay between economic activity and financial markets, many open questions remain. An active area of research in recent years examines the impact of climate change and the uncertainty in climate forecasts on economics outcomes. A presenter on the first day of the workshop will provide the audience with a set of empirical facts related to climate change and climate uncertainty using economic and financial data on US energy production, firms, and temperature data. Importantly, the author of the study can demonstrate that during the past two decades stocks of firms with a higher exposure to climate change offer investors lower investment returns. So, negative economic effects of climate change are already clearly visible in asset pricing data.
The insights of this presentation should serve as a warning signal to investors and managers to account for risks induced by uncertainty from climate change in their future investment decisions.
Many managers, policy makers, and investors rely on professional forecasters for information on economic activity. Naturally the question arises how reliable such forecasts are in practice. The co-author of a new study on the performance of professional forecasters will present evidence on sometimes large distortions in their forecasts. Survey respondents almost always place too much weight on their own forecasts relative to other information. Estimates imply that consensus survey forecasts for both inflation and GDP growth oscillate between optimism and pessimism and range over time from 50 to 400% of average annual inflation or GDP growth.
While perhaps not a surprising result, we learn from this new study that even professional forecasters are prone to serious errors in their judgements. Managers and investors should be careful in their reliance on professional forecasts. In addition, they should be critical of their own forecasts.
Including the two afore-mentioned presentations, the SITE Workshop on “Asset Pricing, Macro Finance and Computation” includes a total of 16 presentations on the linkage between financial markets and the macroeconomy.
The three-day workshop on “Asset Pricing, Macro Finance, and Computation” at Stanford University from July 15–17, can be found here: stanford.edu.
