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Expectations and Aggregate Risk

Author

Listed:
  • Lorenzo Bretscher

    (London Business School - Department of Finance)

  • Aytek Malkhozov

    (Board of Governors of the Federal Reserve System)

  • Andrea Tamoni

    (Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick)

Abstract

We estimate agents’ expectations about future fundamentals using a dynamic stochastic general equilibrium model augmented with anticipated shocks. Accounting for agents’ expectations at the business cycle horizon results in aggregate risk factor innovations that have significant explanatory power for the cross section of stock and bond returns. Further, exposure to macroeconomic fluctuations driven purely by expectations is important to explain the value premium. In contrast, exposure to macroeconomic fluctuations due to realized changes in fundamentals is important for the pricing of long-term bonds and cash-flow duration portfolios. We conclude that accounting for agents’ expectations advances our understanding of the aggregate risk.

Suggested Citation

  • Lorenzo Bretscher & Aytek Malkhozov & Andrea Tamoni, 2021. "Expectations and Aggregate Risk," Swiss Finance Institute Research Paper Series 21-68, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2168
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    More about this item

    Keywords

    News Shocks; Consumption-CAPM; Cross Section of Returns; Market-to-Book Decomposition;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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