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Risk aversion, investor information and stock market volatility

Author

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  • Lansing, Kevin J.
  • LeRoy, Stephen F.

Abstract

This paper employs a standard asset pricing model to derive theoretical volatility measures in a setting that allows for varying degrees of investor information about the dividend process. We show that the volatility of the price–dividend ratio increases monotonically with investor information but the relationship between investor information and equity return volatility (or equity premium volatility) can be non-monotonic, depending on risk aversion and other parameter values. Under some plausible calibrations and information assumptions, we show that the model can match the standard deviations of equity market variables in long-run U.S. data. In the absence of concrete knowledge about investors׳ information, it becomes more difficult to conclude that observed volatility in the data is excessive.

Suggested Citation

  • Lansing, Kevin J. & LeRoy, Stephen F., 2014. "Risk aversion, investor information and stock market volatility," European Economic Review, Elsevier, vol. 70(C), pages 88-107.
  • Handle: RePEc:eee:eecrev:v:70:y:2014:i:c:p:88-107
    DOI: 10.1016/j.euroecorev.2014.03.009
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Gelain, Paolo & Lansing, Kevin J., 2014. "House prices, expectations, and time-varying fundamentals," Journal of Empirical Finance, Elsevier, vol. 29(C), pages 3-25.
    2. Kevin J. Lansing, 2015. "Asset Pricing with Concentrated Ownership of Capital and Distribution Shocks," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(4), pages 67-103, October.
    3. Lansing, Kevin J. & Ma, Jun, 2017. "Explaining exchange rate anomalies in a model with Taylor-rule fundamentals and consistent expectations," Journal of International Money and Finance, Elsevier, vol. 70(C), pages 62-87.
    4. Rui Menezes & Sonia Bentes, 2016. "Hysteresis and Duration Dependence of Financial Crises in the US: Evidence from 1871-2016," Papers 1610.00259, arXiv.org.
    5. Lansing, Kevin J., 2016. "On variance bounds for asset price changes," Journal of Financial Markets, Elsevier, vol. 28(C), pages 132-148.

    More about this item

    Keywords

    Asset pricing; Excess volatility; Variance bounds; Risk aversion; Imperfect information;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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