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Valuation Risk Revalued

Author

Listed:
  • Oliver de Groot
  • Alexander W. Richter
  • Nathanial A. Throckmorton

Abstract

This paper shows the recent success of valuation risk (time-preference shocks in EpsteinZin utility) in resolving asset pricing puzzles rests sensitively on an undesirable asymptote that occurs because the preference specification fails to satisfy a key restriction on the weights in the Epstein-Zin time-aggregator. When we revise the preferences to satisfy the restriction in a simple asset pricing model, the puzzles resurface. However, when estimating a sequence of Bansal-Yaron long-run risk models, we find valuation risk under the revised specification consistently improves the ability of the models to match asset price and cash-flow dynamics.

Suggested Citation

  • Oliver de Groot & Alexander W. Richter & Nathanial A. Throckmorton, 2019. "Valuation Risk Revalued," Working Papers 201904, University of Liverpool, Department of Economics.
    • Handle: RePEc:liv:livedp:201904
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    File URL: https://www.liverpool.ac.uk/media/livacuk/schoolofmanagement/research/economics/Valuation,Risk,Revalued.pdf
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    References listed on IDEAS

    as
    1. Oliver de Groot & Alexander W. Richter & Nathaniel A. Throckmorton, 2018. "Uncertainty Shocks in a Model of Effective Demand: Comment," Econometrica, Econometric Society, vol. 86(4), pages 1513-1526, July.
    2. Beeler, Jason & Campbell, John Y., 2012. "The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment," Critical Finance Review, now publishers, vol. 1(1), pages 141-182, January.
    3. Kollmann, Robert, 2016. "International business cycles and risk sharing with uncertainty shocks and recursive preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 72(C), pages 115-124.
    4. Frank Schorfheide & Dongho Song & Amir Yaron, 2018. "Identifying Long‐Run Risks: A Bayesian Mixed‐Frequency Approach," Econometrica, Econometric Society, vol. 86(2), pages 617-654, March.
    5. 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.
    6. 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.
    7. Walter Pohl & Karl Schmedders & Ole Wilms, 2018. "Higher Order Effects in Asset Pricing Models with Long‐Run Risks," Journal of Finance, American Finance Association, vol. 73(3), pages 1061-1111, June.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Epstein-Zin Utility; Asset Pricing; 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

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