Cash flow and risk premium dynamics in an equilibrium asset-pricing model with recursive preferences

Under linear approximations for asset prices and the assumption of independence between expected consumption growth and time-varying volatility, long-run risks models imply constant market prices of risks and often generate counterfactual results about asset return and cash ?ow predictability. We develop and estimate a nonlinear equilibrium asset pricing model with recursive preferences and a ?exible econometric speci?cation of cash ?ow processes. While in many long-run risks models time-varying volatility in?uences only risk premium but not expected cash ?ows, in our model a common set of risk factors drive both expected cash ?ow and risk premium dynamics. This feature helps the model to overcome two main criticisms against long-run risk models following Bansal and Yaron (2004): the over-predictability of cash ?ows by asset prices and the tight relation between time-varying risk premia and growth volatility. Our model extends the approach in Le and Singleton (2010) to a setting with multiple cash ?ows. We estimate the model using the long-run historical data in the U.S. and ?nd that the model with generalized market prices of risks produces cash ?ow and return predictability that are more consistent with the data.