Working Paper: CEPR ID: DP14588
Authors: Oliver de Groot; Alexander Richter; Nathaniel Throckmorton
Abstract: This paper shows the success of valuation risk—time-preference shocks in Epstein-Zinutility—in resolving asset pricing puzzles rests sensitively on the way it is introduced. Thespecification used in the literature violates several desirable properties of recursive preferencesbecause the weights in the Epstein-Zin time-aggregator do not sum to one. When we revise thespecification in a simple asset pricing model the puzzles resurface. However, when estimatinga sequence of increasingly rich models, we find valuation risk under the revised specificationconsistently improves the ability of the models to match asset price and cash-flow dynamics.
Keywords: recursive utility; asset pricing; equity premium puzzle; risk-free rate puzzle
JEL Codes: C15; D81; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| specification of valuation risk (G32) | equilibrium determination of asset prices (G19) |
| revised specification of valuation risk (G32) | model performance (C52) |
| valuation risk (G32) | equity premium (G12) |
| valuation risk (G32) | risk-free rate dynamics (E43) |
| current specification (L15) | violations of desirable properties (P37) |
| revised specification (Y20) | continuity and consistent equilibrium moments (C62) |