Working Paper: CEPR ID: DP5951
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 the general method of moments, 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. However, the stock-bond return correlation implied by the model is somewhat higher than in the data.
Keywords: countercyclical risk aversion; equity premium; excess volatility; habit persistence; return predictability; stock-bond return 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 (D81) | expected stock returns (G17) |
| stochastic risk aversion (D81) | expected bond returns (G12) |
| stochastic risk aversion (D81) | risk premia of stocks (G17) |
| stochastic risk aversion (D81) | risk premia of bonds (G12) |
| stochastic risk aversion (D81) | predictability of excess stock returns (G17) |
| stochastic risk aversion (D81) | predictability of excess bond returns (G12) |
| stochastic risk aversion (D81) | stock-bond return correlation (G12) |