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Long Run Risks, the Macroeconomy, and Asset Prices

Long Run Risks, the Macroeconomy, and Asset Prices American Economic Review: Papers & Proceedings 100 (May 2010): 542–546 http://www.aeaweb.org/articles.php?doi=10.1257/aer.100.2.542 Long Run Risks and asset MaRkets †By Ravi Bansal, Dana Kiku, and Amir Yaron* Ravi Bansal and Amir Yaron (2004) developed the Long Run Risk (LRR) model which emphasizes the role of long run risks, that is, low-frequency movements in consumption growth rates and volatility, in accounting for a wide range of asset pricing puzzles. In this article we present a generalized LRR model, which allows us to study the role of cyclical fluctuations and macroeconomic crises on asset prices and expected returns. The Bansal and Yaron (2004) LRR model contains (i) a persistent expected consumption growth component, (ii) long-run variation in consumption volatility, and (iii) preference for early resolution of uncertainty. To evaluate the role of cyclical risks, we incorporate a cyclical component in consumption growth—this component is stationary in levels. To study financial market crises, we also entertain jumps in consumption growth and volatility. We find that the magnitude of risk compensation for cyclical risks in consumption critically depends on the magnitude of the intertemporal elasticity of substitution (IES). When the IES is larger than one, cyclical risks carry a very small risk premium. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Review American Economic Association

Long Run Risks, the Macroeconomy, and Asset Prices

American Economic Review , Volume 100 (2) – May 1, 2010

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Publisher
American Economic Association
Copyright
Copyright © 2010 by the American Economic Association
Subject
Papers
ISSN
0002-8282
DOI
10.1257/aer.100.2.542
Publisher site
See Article on Publisher Site

Abstract

American Economic Review: Papers & Proceedings 100 (May 2010): 542–546 http://www.aeaweb.org/articles.php?doi=10.1257/aer.100.2.542 Long Run Risks and asset MaRkets †By Ravi Bansal, Dana Kiku, and Amir Yaron* Ravi Bansal and Amir Yaron (2004) developed the Long Run Risk (LRR) model which emphasizes the role of long run risks, that is, low-frequency movements in consumption growth rates and volatility, in accounting for a wide range of asset pricing puzzles. In this article we present a generalized LRR model, which allows us to study the role of cyclical fluctuations and macroeconomic crises on asset prices and expected returns. The Bansal and Yaron (2004) LRR model contains (i) a persistent expected consumption growth component, (ii) long-run variation in consumption volatility, and (iii) preference for early resolution of uncertainty. To evaluate the role of cyclical risks, we incorporate a cyclical component in consumption growth—this component is stationary in levels. To study financial market crises, we also entertain jumps in consumption growth and volatility. We find that the magnitude of risk compensation for cyclical risks in consumption critically depends on the magnitude of the intertemporal elasticity of substitution (IES). When the IES is larger than one, cyclical risks carry a very small risk premium.

Journal

American Economic ReviewAmerican Economic Association

Published: May 1, 2010

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