Research Interests: asset pricing, financial econometrics, portfolio choice
Phd, Harvard University, 2000; AB, Harvard College, 1996
Wharton: 2003-present. Previous appointments: Stern School of Business, New York University
Jessica Wachter is the Richard B. Worley Professor of Financial Management at the Wharton School of Business of the University of Pennsylvania. She holds a PhD in Business Economics and an undergraduate degree in Mathematics from Harvard University. She is currently serves on the board of the Western Finance Assocation, and as an associate editor of Quantitative Economics. Previously, she served as associate editor at the Review of Financial Studies and the Journal of Economic Theory and as a board member of the American Finance Association. Her research interests include asset pricing models that incorporate rare events and behavioral finance. She has published numerous papers in the Journal of Finance, the Journal of Financial Economics, the Review of Financial Studies, and other journals.
Abstract: Yields on sovereign debt have declined dramatically across the developed world over the last half-century. Standard explanations of this decline include a change in discount rates due to an aging population or increased demand for assets from abroad. We show that these explanations encounters difficulties when confronted with the full range of evidence across asset classes. We propose that this decline was due to a decline in inflation expectations/default risk on sovereign debt. We argue that this explanation has a better chance of capturing an important feature of the decline in interest rates: namely that it has spanned centuries. We incorporate this explanation into an otherwise standard model of asset prices, augmented with inventory storage. An effective lower bound implies the existence of such a storage technology; otherwise there are arbitrage opportunities within the model. Including storage in a production-based model allows us to match the reduction in investment and GDP growth observed over the last three decades.
Abstract: What is the connection between financing constraints and the equity premium? To answer this question, we build a model with inalienable human capital, in which investors decide to finance individuals who can potentially become skilled. Though investment in skill is always optimal, it does not take place in some states of the world, due to moral hazard. In other states of the world, individuals acquire skill; however outside investors and individuals inefficiently share risk. We show that this simple moral hazard problem and the resultant financing friction leads to a realistic equity premium, a low risk riskfree rate, and severe negative consequences for distribution of wealth and for welfare. When investment fails to take place, the economy enters an endogenous disaster state. We show that the possibility of these disaster states distorts risk prices, even under calibrations in which they never occur in equilibrium.
Abstract: Financial crises appear to have long-lasting effects, even after the crisis itself has past. This paper offers a simple explanation through Bayesian learning from rare events. Agents face a latent and time-varying probability of economic disaster. When a disaster occurs, learning results in greater effects on asset prices because agents update their probability of future disasters. Moreover, agents' belief that the disaster risk is high can rationally persist for years, even when it is in fact low. We generalize the model to allow for a noisy signal of the disaster probability. This generalized model explains excess stock market volatility together with negative skewness, effects that previous models in the literature struggle to explain.
Abstract: A growing literature shows that credit indicators forecast aggregate real outcomes. While the literature has proposed various explanations, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless, model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks. This leads to endogenous dispersion in credit quality that varies over time and predicts future excess returns and real outcomes.
Abstract: Financial crises tend to follow rapid credit expansions. Causality, however, is far from obvious. We show how this pattern arises naturally when financial intermediaries optimally exploit economic rents that drive their franchise value. As this franchise value varies over the business cycle, so too do the incentives to engage in risky lending. The model leads to novel insights on the effects of recent unconventional monetary policies in developed economies. We argue that bank lending might have responded less than expected to these interventions because they enhanced franchise value, inadvertently encouraging banks to pursue safer investments in low-risk government securities.
Abstract: Studies of human memory indicate that features of an event evoke memories of prior associated contextual states, which in turn become associated with the current event's features. This mechanism allows the remote past to influence the present, even as agents gradually update their beliefs about their environment. We apply the context framework from the memory literature to four problems in asset pricing and portfolio choice: over-persistence of beliefs, providence of financial crises, price momentum, and the impact of fear on asset allocation. These examples suggest a recasting of neoclassical rational expectations in terms of beliefs as governed by principles of human memory.
Sang Byung Seo and Jessica Wachter (2019), Option Prices in a Model with Stochastic Disaster Risk, Management Science.
Abstract: Contrary to well-known asset pricing models, volatilities implied by equity index options exceed realized stock market volatility and exhibit a pattern known as the volatility skew. We explain both facts using a model that can also account for the mean and volatility of equity returns. Our model assumes a small risk of economic disaster that is calibrated based on international data on large consumption declines. We allow the disaster probability to be stochastic, which turns out to be crucial to the model's ability both to match equity volatility and to reconcile option prices with macroeconomic data on disasters.
This course provides an introduction to the theory, the methods, and the concerns of corporate finance. The concepts developed in FNCE 100 form the foundation for all elective finance courses. The main topics include: 1) the time value of money and capital budgeting techniques; 2) uncertainty and the trade-off between risk and return; 3) security market efficiency; 4) optimal capital structure, and 5) dividend policy decisions. ACCT 101 + STAT 101 may be taken concurrently.
Integrates the work of the various courses and familiarizes the student with the tools and techniques of research.
Independent Study Projects require extensive independent work and a considerable amount of writing. ISP in Finance are intended to give students the opportunity to study a particular topic in Finance in greater depth than is covered in the curriculum. The application for ISP's should outline a plan of study that requires at least as much work as a typical course in the Finance Department that meets twice a week. Applications for FNCE 899 ISP's will not be accepted after the THIRD WEEK OF THE SEMESTER. ISP's must be supervised by a Standing Faculty member of the Finance Department.
The objective of this course is to undertake a rigorous study of the theoretical foundations of modern financial economics. The course will cover the central themes of modern finance including individual investment decisions under uncertainty, stochastic dominance, mean variance theory, capital market equilibrium and asset valuation, arbitrage pricing theory, option pricing, and incomplete markets, and the potential application of these themes. Upon completion of this course, students should acquire a clear understanding of the major theoretical results concerning individuals' consumption and portfolio decisions under uncertainty and their implications for the valuation of securities.