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Short-run risk, business cycle, and the value premium

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  • He, Yunhao
  • Leippold, Markus

Abstract

We jointly explain the equity and value premium variations in a model with both short-run (SRR) and long-run (LRR) consumption risk. In our empirical analysis, we find that SRR varies with the business cycle, and it has a substantial predictive power for market excess returns and the value premium—both in-sample and out-of-sample. The LRR component also differs significantly from zero, and value stocks have a larger exposure to both LRR and SRR than growth stocks. To explain these patterns in asset returns, we propose an extended LRR model. The model can be solved using log-linear approximations with economically small errors.

Suggested Citation

  • He, Yunhao & Leippold, Markus, 2020. "Short-run risk, business cycle, and the value premium," Journal of Economic Dynamics and Control, Elsevier, vol. 120(C).
    • Handle: RePEc:eee:dyncon:v:120:y:2020:i:c:s0165188920301615
    DOI: 10.1016/j.jedc.2020.103993
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    1. Fabozzi, Francesco A. & Nazemi, Abdolreza, 2023. "News-based sentiment and the value premium," Journal of International Money and Finance, Elsevier, vol. 136(C).

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    More about this item

    Keywords

    Long-run and short-run consumption risk; Value premium; Business cycle; Portfolio selection; stochastic covariance;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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