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Risk, Uncertainty and Asset Prices

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  • Geert Bekaert
  • Eric Engstrom
  • Yuhang Xing

Abstract

We identify the relative importance of changes in the conditional variance of fundamentals (which we call %u201Cuncertainty%u201D) and changes in risk aversion (%u201Crisk%u201D for short) in the determination of the term structure, equity prices and risk premiums. Theoretically, we introduce persistent time-varying uncertainty about the fundamentals in an external habit model. The model matches the dynamics of dividend and consumption growth, including their volatility dynamics and many salient asset market phenomena. While the variation in dividend yields and the equity risk premium is primarily driven by risk, uncertainty plays a large role in the term structure and is the driver of counter-cyclical volatility of asset returns.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12248.

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Date of creation: May 2006
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Publication status: published as Bekaert, Geert & Engstrom, Eric & Xing, Yuhang, 2009. "Risk, uncertainty, and asset prices," Journal of Financial Economics, Elsevier, vol. 91(1), pages 59-82, January.
Handle: RePEc:nbr:nberwo:12248

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