We study the role of information in asset pricing models with long-run cash flow risk. To illustrate the importance of the information structure, we show how the implications of the long-run risk paradigm for the cross-sectional properties of stock returns and cash flow duration are affected by information. When investors can fully distinguish short- and long- run consumption risk components of dividend growth innovations (full information), only exposure to long-run consumption risk generates significant risk premia, implying that high-return value stocks are long-duration assets, contrary to the historical data. By contrast, when investors observe the change in consumption and dividends each period but not the individual components of that change (limited information), exposure to short-run risk can generate large risk premia, so that high-return value stocks are short-duration assets while low-return growth stocks are long-duration assets, as in the data. We also show that, in order to explain empirical finding that long-horizon equity is less risky than short-horizon equity, the properties of the cash flow model and the values of primitive preference parameters must be quite different from those emphasized in the existing long-run risk literature.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
12912.
Length: Date of creation: Feb 2007 Date of revision: Handle: RePEc:nbr:nberwo:12912
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Find related papers by JEL classification: E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data) G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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Lu Zhang, 2005.
"The Value Premium,"
Journal of Finance,
American Finance Association, vol. 60(1), pages 67-103, 02.
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Tano Santos & Pietro Veronesi, 2004.
"Conditional Betas,"
NBER Working Papers
10413, National Bureau of Economic Research, Inc.
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