Working Paper: CEPR ID: DP9262
Authors: Rui Albuquerque; Martin Eichenbaum; Sergio Rebelo
Abstract: Standard representative-agent models have difficulty in accounting for the weak correlation between stock returns and measurable fundamentals, such as consumption and output growth. This failing underlies virtually all modern asset-pricing puzzles. The correlation puzzle arises because these models load all uncertainty onto the supply side of the economy. We propose a simple theory of asset pricing in which demand shocks play a central role. These shocks give rise to valuation risk that allows the model to account for key asset pricing moments, such as the equity premium, the bond term premium, and the weak correlation between stock returns and fundamentals.
Keywords: bond yields; equity premium; risk premium
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| demand shocks (E39) | risk-free rate (G12) |
| risk-free rate (G12) | asset prices (G19) |
| demand shocks (E39) | valuation risk (G32) |
| valuation risk (G32) | asset prices (G19) |
| valuation risk (G32) | equity premium (G12) |
| valuation risk (G32) | bond term premium (G12) |
| time-preference shocks (D15) | valuation risk (G32) |
| time-preference shocks (D15) | equity premium (G12) |
| time-preference shocks (D15) | asset prices (G19) |