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Stock and Bond Returns with Moody Investors

Author

Listed:
  • Bekaert, Geert
  • Engstrom, Eric
  • Grenadier, Steve

Abstract

We present a tractable, linear model for the simultaneous pricing of stock and bond returns that incorporates stochastic risk aversion. In this model, analytic solutions for endogenous stock and bond prices and returns are readily calculated. After estimating the parameters of the model by GMM, we investigate a series of classic puzzles of the empirical asset pricing literature. In particular, our model is shown to jointly accommodate the mean and volatility of equity and long-term bond risk premia as well as salient features of the nominal short rate, the dividend yield, and the term spread. Also, the model matches the evidence for predictability of excess stock and bond returns. The stock-bond return correlation implied by the model is, however, somewhat higher than in the data.

Suggested Citation

  • Bekaert, Geert & Engstrom, Eric & Grenadier, Steve, 2004. "Stock and Bond Returns with Moody Investors," CEPR Discussion Papers 4501, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:4501
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    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
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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