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Macroeconomic Volatilities and Long-Run Risks of Asset Prices

Author

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  • Guofu Zhou

    (Olin Business School, Washington University in St. Louis, St. Louis, Missouri 63130, CAFR and CUFE)

  • Yingzi Zhu

    (School of Economics and Management, Tsinghua University, 100084 Beijing, China)

Abstract

In this paper, motivated by existing and growing evidence on multiple macroeconomic volatilities, we extend the long-run risks model by allowing both a long- and a short-run volatility components in the evolution of economic fundamentals. With this extension, the new model not only is consistent with the volatility literature that the stock market is driven by two, rather than one, volatility factors, but also provides significant improvements in fitting various patterns, such as the size of market risk premium, the level of interest rate, degree of dividend yield predictability, and the term structure of variance risk premiums, of both the equity and option data.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2014.1962. This paper was accepted by Jerome Detemple, finance .

Suggested Citation

  • Guofu Zhou & Yingzi Zhu, 2015. "Macroeconomic Volatilities and Long-Run Risks of Asset Prices," Management Science, INFORMS, vol. 61(2), pages 413-430, February.
    • Handle: RePEc:inm:ormnsc:v:61:y:2015:i:2:p:413-430
    DOI: 10.1287/mnsc.2014.1962
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    3. Branger, Nicole & Rodrigues, Paulo & Schlag, Christian, 2018. "Level and slope of volatility smiles in long-run risk models," Journal of Economic Dynamics and Control, Elsevier, vol. 86(C), pages 95-122.
    4. Chen, Xingjiang & Ruan, Xinfeng & Zhang, Wenjun, 2021. "Dynamic portfolio choice and information trading with recursive utility," Economic Modelling, Elsevier, vol. 98(C), pages 154-167.
    5. Branger, Nicole & Rodrigues, Paulo & Schlag, Christian, 2017. "Level and slope of volatility smiles in Long-Run Risk Models," SAFE Working Paper Series 186, Leibniz Institute for Financial Research SAFE.
    6. Atanasov, Victoria, 2018. "World output gap and global stock returns," Journal of Empirical Finance, Elsevier, vol. 48(C), pages 181-197.
    7. He, Yunhao & Leippold, Markus, 2020. "Short-run risk, business cycle, and the value premium," Journal of Economic Dynamics and Control, Elsevier, vol. 120(C).
    8. Ruan, Xinfeng, 2021. "Ambiguity, long-run risks, and asset prices in continuous time," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 115-126.
    9. Buss, Adrian & Vilkov, Grigory & ,, 2018. "Expected Correlation and Future Market Returns," CEPR Discussion Papers 12760, C.E.P.R. Discussion Papers.

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