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Risks For the Long Run: A Potential Resolution of Asset Pricing Puzzles. (2004)

by R Bansal, A Yaron
Venue:Journal of Finance
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Consumption strikes back? Measuring long run risk, working paper,

by Lars Peter Hansen , John C Heaton , Nan Li , Fernando Alvarez , Ravi Bansal , John Cochrane , Ken Judd , Anil Kashyap , Mark Klebanov , Junghoon Lee , Jonathan Parker , Tano Santos , Tom Sargent , Chris Sims , Grace Tsiang , Pietro Veronesi , Kenji Wada , 2005
"... Abstract We characterize and measure a long-run risk return tradeoff for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This tradeoff features the risk prices of cash flows that are realized far into the future but are reflected in asset values. We apply this analysis ..."
Abstract - Cited by 246 (32 self) - Add to MetaCart
Abstract We characterize and measure a long-run risk return tradeoff for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This tradeoff features the risk prices of cash flows that are realized far into the future but are reflected in asset values. We apply this analysis to a claims on aggregate cash flows, as well as to the cash flows from value and growth portfolios. Based on vector autoregressions, we characterize the dynamic response of cash flows to macroeconomic shocks and document that there are important differences in the long-run responses. We isolate those features of a recursive utility model and the consumption dynamics needed for the long run valuation differences among these portfolios to be sizable. Finally, we show how the resulting measurements vary when we alter the statistical specifications of cash flows and consumption growth.
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...or their stochastic counterparts is a familiar tool in the study of dynamic economic models. We apply an analogous idea for the long-run valuation of stochastic cash flows. The resulting valuation allows us to decompose long-run expected returns into the sum of a risk-free return and a long-run risk premium. This long-run risk premium is further decomposed into the product of a measure of long-run exposure to risk and the price of long-run risk. Unlike approaches that examine the relationship between one-period expected returns and preferences that feature a concern about long-run risk (e.g. (Bansal and Yaron 2004) and (Campbell and Vuolteenaho 2004)) our development focuses on the intertemporal composition of risk prices, and in particular on the implied risk prices for cash flows far into the future. The result we establish for long-run expected returns has the same structure as the standard decomposition of one-period expected returns into a risk-free component plus the product of the price of risk and the risk exposure. 2 2.1 Stochastic discount factors Uncertainty in the economy is given by the dynamics of a state vector xt which evolves according to a first-order vector autoregression: xt+1 = Gxt ...

Variable Rare Disasters: An Exactly Solved Framework for

by Xavier Gabaix - Ten Puzzles in Macro Finance, Working Paper, NYU , 2009
"... This article incorporates a time-varying severity of disasters into the hy- ..."
Abstract - Cited by 163 (10 self) - Add to MetaCart
This article incorporates a time-varying severity of disasters into the hy-

Stock return predictability: Is it there?

by Andrew Ang, Geert Bekaert , 2001
"... We ask whether stock returns in France, Germany, Japan ... by three instruments: the dividend yield, the earnings yield and the short rate. The predictability regression is suggested by a present value model with earnings growth, payout ratios and the short rate as state variables. We find the short ..."
Abstract - Cited by 127 (5 self) - Add to MetaCart
We ask whether stock returns in France, Germany, Japan ... by three instruments: the dividend yield, the earnings yield and the short rate. The predictability regression is suggested by a present value model with earnings growth, payout ratios and the short rate as state variables. We find the short rate to be the only robust short-run predictor of excess returns, and find little evidence of excess return predictability by earnings or dividend yields across all countries. There is no evidence of long-horizon return predictability once we account for finite sample influence. Cross-country predictability is stronger than predictability using local instruments. Finally, dividend and earnings yields predict future cashflow growth

On the relationship between the conditional mean and volatility of stock returns: A latent VAR approach

by Michael W. Brandt, Qiang Kang , 2002
"... ..."
Abstract - Cited by 108 (3 self) - Add to MetaCart
Abstract not found

Macroeconomic conditions and the puzzles of credit spreads and capital structure

by Hui Chen , 2008
"... Investors demand high risk premia for defaultable claims, because (i) defaults tend to concentrate in bad times when marginal utility is high; (ii) default losses are high during such times. I build a structural model of financing and default decisions in an economy with business-cycle variations in ..."
Abstract - Cited by 106 (13 self) - Add to MetaCart
Investors demand high risk premia for defaultable claims, because (i) defaults tend to concentrate in bad times when marginal utility is high; (ii) default losses are high during such times. I build a structural model of financing and default decisions in an economy with business-cycle variations in expected growth rates and volatility, which endogenously generate countercyclical comovements in risk prices, default probabilities, and default losses. Credit risk premia in the calibrated model not only can quantitatively account for the high corporate bond yield spreads and low leverage ratios in the data, but have rich implications for firms’ financing decisions.

The Declining Equity Premium: What Role Does Macroeconomic Risk Play?

by Martin Lettau, Sydney C. Ludvigson, Jessica A. Wachter - THE REVIEW OF FINANCIAL STUDIES , 2006
"... ..."
Abstract - Cited by 105 (10 self) - Add to MetaCart
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Why is long-horizon equity less risky? A durationbased explanation of the value premium, NBER working paper

by Martin Lettau, Jessica A. Wachter , 2005
"... We propose a dynamic risk-based model that captures the value premium. Firms are modeled as long-lived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model im ..."
Abstract - Cited by 105 (21 self) - Add to MetaCart
We propose a dynamic risk-based model that captures the value premium. Firms are modeled as long-lived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model implies that growth firms covary more with the discount rate than do value firms, which covary more with cash flows. When calibrated to explain aggregate stock market behavior, the model accounts for the observed value premium, the high Sharpe ratios on value firms, and the poor performance of the CAPM. THIS PAPER PROPOSES A DYNAMIC RISK-BASED MODEL that captures both the high expected returns on value stocks relative to growth stocks, and the failure of the capital asset pricing model to explain these expected returns. The value premium, first noted by Graham and Dodd (1934), is the finding that assets with a high ratio of price to fundamentals (growth stocks) have low expected returns relative to assets with a low ratio of price to fundamentals (value stocks). This

Agent-based computational finance

by Blake Lebaron - in Handbook of Computational Economics, Agent-based Computational Economics , 2006
"... This paper surveys research on computational agent-based models used in finance. It will concentrate on models where the use of computational tools is critical in the process of crafting models which give insights into the importance and dynamics of investor heterogeneity in many financial settings. ..."
Abstract - Cited by 100 (3 self) - Add to MetaCart
This paper surveys research on computational agent-based models used in finance. It will concentrate on models where the use of computational tools is critical in the process of crafting models which give insights into the importance and dynamics of investor heterogeneity in many financial settings.

Can Time-varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?

by Jessica A. Wachter , 2012
"... ..."
Abstract - Cited by 92 (9 self) - Add to MetaCart
Abstract not found

Rare Disasters, Asset Prices and Welfare Costs. American Economic Review, forthcoming

by J. Barro , 2009
"... A representative-consumer model with Epstein-Zin-Weil preferences and i.i.d. shocks, including rare disasters, accords with observed equity premia and risk-free rates if the coefficient of relative risk aversion equals 3–4. If the intertemporal elasticity of substitution exceeds one, an increase in ..."
Abstract - Cited by 87 (0 self) - Add to MetaCart
A representative-consumer model with Epstein-Zin-Weil preferences and i.i.d. shocks, including rare disasters, accords with observed equity premia and risk-free rates if the coefficient of relative risk aversion equals 3–4. If the intertemporal elasticity of substitution exceeds one, an increase in uncertainty lowers the price-dividend ratio for equity, and a rise in the expected growth rate raises this ratio. Calibrations indicate that society would willingly reduce GDP by around 20 percent each year to eliminate rare disasters. The welfare cost from usual economic fluctuations is much smaller, though still important, corresponding to lowering GDP by about 1.5 percent each year. (JEL E13, E21, E22, E32) In a previous study, Barro (2006), I used the Thomas A. Rietz (1988) idea of rare economic disasters to explain the equity premium and related asset-pricing puzzles. My quantitative examination of large macroeconomic contractions in 35 countries during the twentieth century suggested a disaster probability of roughly 2 percent per year. The size distribution of GDP contractions during these events ranged between 15 percent (the arbitrary lower bound) and over 60
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