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Consumption Strikes Back?: Measuring Long-Run Risk

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Author Info
Lars Peter Hansen
John Heaton
Nan Li

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Abstract

We characterize and measure a long-run risk return tradeoff for the valuation of financial cash flows that are exposed to fluctuations in macroeconomic growth. This tradeoff features components of financial cash flows that are only realized far into the future but are still reflected in current asset values. We use the recursive utility model with empirical inputs from vector autoregressions to quantify this relationship; and we study the long-run risk differences in aggregate securities and in portfolios constructed based on the ratio of book equity to market equity. Finally, we explore the resulting measurement challenges and the implied sensitivity to alternative specifications of stochastic growth.

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Publisher Info
Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11476.

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Date of creation: Jul 2005
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Handle: RePEc:nbr:nberwo:11476

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Find related papers by JEL classification:
G1 - Financial Economics - - General Financial Markets
E2 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment

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  1. Mariano M. Croce & Martin Lettau & Sydney C. Ludvigson, 2007. "Investor Information, Long-Run Risk, and the Duration of Risky Cash-Flows," NBER Working Papers 12912, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Ravi Bansal, 2007. "Long-Run Risks and Financial Markets," NBER Working Papers 13196, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Sydney Ludvigson, 2008. "The Research Agenda: Sydney Ludvigson on Empirical Evaluation of Economic Theories of Risk Premia," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 9(2), April. [Downloadable!]
  4. Michael F. Gallmeyer & Burton Hollifield & Francisco J. Palomino & Stanley E. Zin, 2007. "Arbitrage-free bond pricing with dynamic macroeconomic models," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 305-326. [Downloadable!]
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  5. Ravi Bansal, 2007. "Long-run risks and financial markets," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 283-300. [Downloadable!]
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