IDEAS home Printed from https://ideas.repec.org/p/fip/feddwp/1808.html
   My bibliography  Save this paper

Valuation Risk Revalued

Author

Listed:

Abstract

The recent asset pricing literature finds valuation risk is an important determinant of key asset pricing moments. Valuation risk is modelled as a time preference shock within Epstein-Zin recursive utility preferences. While this form of valuation risk appears to fit the data extremely well, we show the preference specification violates an economically meaningful restriction on the weights in the Epstein-Zin time-aggregator. The same model with the corrected preference specification performs nearly as well at matching asset pricing moments, but only if the risk aversion parameter is well above the accepted range of values used in the literature. When the corrected preference specification is combined with Bansal-Yaron long-run risk, the estimated model significantly downgrades the role of valuation risk in determining asset prices. The only significant contribution of valuation risk is to help match the volatility of the risk-free rate.

Suggested Citation

  • de Groot, Oliver & Richter, Alexander W. & Throckmorton, Nathaniel, 2018. "Valuation Risk Revalued," Working Papers 1808, Federal Reserve Bank of Dallas.
    • Handle: RePEc:fip:feddwp:1808
    DOI: 10.24149/wp1808
    as

    Download full text from publisher

    File URL: https://www.dallasfed.org/-/media/documents/research/papers/2018/wp1808.pdf
    File Function: Full text
    Download Restriction: no

    References listed on IDEAS

    as
    1. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-969, July.
    2. 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.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Epstein-Zin Utility; Valuation Risk; Equity Premium Puzzle; Risk-Free Rate Puzzle;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:feddwp:1808. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Amy Chapman). General contact details of provider: http://edirc.repec.org/data/frbdaus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.