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Macroeconomic Risk and Idiosyncratic Risk-taking

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  • Zhiyao Chen
  • Ilya A Strebulaev

Abstract

We develop and estimate a dynamic model of risk-shifting over the business cycle. First, equity holders with Epstein-Zin preferences increase their taking of idiosyncratic risk substantially more than the standard model in repeated games, because they perceive the arrival probability of bad states to be higher than the actual probability and prefer an early resolution of macroeconomic uncertainty. Second, sudden switches to bad states and large shocks in the bad states induce the countercyclical and “synchronized” idiosyncratic risk. Third, combined with the high market risk premium in the bad states, clustered risk-taking generates a countercyclical idiosyncratic volatility discount on equity returns.Received July 1, 2017; editorial decision January 22, 2018 by Editor Stijn Van Nieuwerburgh. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Suggested Citation

  • Zhiyao Chen & Ilya A Strebulaev, 2019. "Macroeconomic Risk and Idiosyncratic Risk-taking," The Review of Financial Studies, Society for Financial Studies, vol. 32(3), pages 1148-1187.
    • Handle: RePEc:oup:rfinst:v:32:y:2019:i:3:p:1148-1187.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhy066
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    Cited by:

    1. Yin, Libo & Lu, Man, 2022. "Oil uncertainty and firms' risk-taking," Energy Economics, Elsevier, vol. 108(C).
    2. Xia, Xin & Gan, Liu, 2020. "SME financing with new credit guarantee contracts over the business cycle," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 515-538.
    3. Andrade, Sandro C. & Ekponon, Adelphe & Jeanneret, Alexandre, 2023. "Sovereign risk premia and global macroeconomic conditions," Journal of Financial Economics, Elsevier, vol. 147(1), pages 172-197.
    4. Saurabh Mishra & Sachin B. Modi & Michael A. Wiles, 2022. "Economic policy uncertainty and shareholder wealth: the role of marketing, operations, and R&D capabilities," Journal of the Academy of Marketing Science, Springer, vol. 50(5), pages 1011-1031, September.
    5. Brockman, Paul & Guo, Tao & Vivero, Maria Gabriela & Yu, Wayne, 2022. "Is idiosyncratic risk priced? The international evidence," Journal of Empirical Finance, Elsevier, vol. 66(C), pages 121-136.

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