Working Paper: CEPR ID: DP4501
Authors: Geert Bekaert; Eric Engstrom; Steve Grenadier
Abstract: We present a tractable, linear model for the simultaneous pricing of stock and bond returns that incorporates stochastic risk aversion. In this model, analytic solutions for endogenous stock and bond prices and returns are readily calculated. After estimating the parameters of the model by GMM, we investigate a series of classic puzzles of the empirical asset pricing literature. In particular, our model is shown to jointly accommodate the mean and volatility of equity and long-term bond risk premia as well as salient features of the nominal short rate, the dividend yield, and the term spread. Also, the model matches the evidence for predictability of excess stock and bond returns. The stock-bond return correlation implied by the model is, however, somewhat higher than in the data.
Keywords: empirical asset pricing; macroeconomic factors; stock-bond correlation
JEL Codes: E44; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stochastic risk aversion (qt) (D81) | expected returns on stock and bond (G12) |
| increase in stochastic risk aversion (qt) (D81) | adjustment in marginal rate of substitution (D11) |
| adjustment in marginal rate of substitution (D11) | impact on pricing kernel (D49) |
| impact on pricing kernel (D49) | asset returns (G19) |
| past returns (G17) | future expectations of stock and bond returns (G12) |
| model generates bond-stock return correlation (C10) | higher than observed correlation in data (C10) |