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Risk, Uncertainty and Asset Prices

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  • Geert Bekaert
  • Eric Engstrom
  • Yuhang Xing

Abstract

We identify the relative importance of changes in the conditional variance of fundamentals (which we call "uncertainty") and changes in risk aversion ("risk" for short) in the determination of the term structure, equity prices and risk premiums. Theoretically, we introduce persistent time-varying uncertainty about the fundamentals in an external habit model. The model matches the dynamics of dividend and consumption growth, including their volatility dynamics and many salient asset market phenomena. While the variation in dividend yields and the equity risk premium is primarily driven by risk, uncertainty plays a large role in the term structure and is the driver of counter-cyclical volatility of asset returns.

Suggested Citation

  • Geert Bekaert & Eric Engstrom & Yuhang Xing, 2006. "Risk, Uncertainty and Asset Prices," NBER Working Papers 12248, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12248
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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