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Valuation Risk Revalued

Author

Listed:
  • Oliver de Groot

    () (University of St Andrews)

  • Alexander W. Richter

    () (Federal Reserve Bank of Dallas)

  • Nathaniel A. Throckmorton

    () (College of William & Mary)

Abstract

This paper shows the recent success of valuation risk (time-preference shocks in Epstein- Zin 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. In a Bansal-Yaron long-run risk model, our revised valuation risk specification that satisfies the restriction provides a superior empirical fit. The results also show that valuation risk no longer has a major role in matching the mean equity premium and risk-free rate but is crucial for matching the volatility and autocorrelation of the risk-free rate.

Suggested Citation

  • Oliver de Groot & Alexander W. Richter & Nathaniel A. Throckmorton, 2018. "Valuation Risk Revalued," CDMA Working Paper Series 201803, Centre for Dynamic Macroeconomic Analysis.
  • Handle: RePEc:san:cdmawp:1803
    as

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    File URL: http://www.st-andrews.ac.uk/~wwwecon/repecfiles/2/1803.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. 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.
    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. 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.
    5. 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.
    6. Walter Pohl & Karl Schmedders & Ole Wilms, 2018. "Higher Order Effects in Asset Pricing Models with Longā€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; 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

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