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Growth risks, asset prices, and welfare

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  • Croce, Mariano M.

Abstract

I connect interest rates, risk premia and welfare costs of long-run consumption uncertainty in a setting with Epstein and Zin (1989) preferences. I find that long-run uncertainty can create significant welfare costs even when risk aversion is moderate and the short-run consumption volatility low. I document that the risk-free rate puzzle is a key determinant of the welfare costs.

Suggested Citation

  • Croce, Mariano M., 2021. "Growth risks, asset prices, and welfare," Economics Letters, Elsevier, vol. 202(C).
    • Handle: RePEc:eee:ecolet:v:202:y:2021:i:c:s016517652100094x
    DOI: 10.1016/j.econlet.2021.109817
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    References listed on IDEAS

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    1. Obstfeld, Maurice, 1994. "Evaluating risky consumption paths: The role of intertemporal substitutability," European Economic Review, Elsevier, vol. 38(7), pages 1471-1486, August.
    2. Larry G. Epstein & Emmanuel Farhi & Tomasz Strzalecki, 2014. "How Much Would You Pay to Resolve Long-Run Risk?," American Economic Review, American Economic Association, vol. 104(9), pages 2680-2697, September.
    3. Ravi Bansal & Marcelo Ochoa, 2011. "Welfare Costs of Long-Run Temperature Shifts," NBER Working Papers 17574, National Bureau of Economic Research, Inc.
    4. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    5. Croce, Mariano M. & Nguyen, Thien T. & Schmid, Lukas, 2012. "The market price of fiscal uncertainty," Journal of Monetary Economics, Elsevier, vol. 59(5), pages 401-416.
    6. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
    7. Jim Dolmas, 1998. "Risk Preferences and the Welfare Cost of Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(3), pages 646-676, July.
    8. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, August.
    9. M. Max Croce & Howard Kung & Thien T. Nguyen & Lukas Schmid, 2012. "Fiscal Policies and Asset Prices," Review of Financial Studies, Society for Financial Studies, vol. 25(9), pages 2635-2672.
    10. Mariano M. Croce, 2006. "Welfare Costs, Long Run Consumption Risk, and a Production Economy," 2006 Meeting Papers 582, Society for Economic Dynamics.
    11. Thien Nguyen & Lukas Schmid & Howard Kung & Mariano Croce, 2012. "Fiscal Policies and Asset Prices," 2012 Meeting Papers 565, Society for Economic Dynamics.
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