Working Paper: NBER ID: w11193
Authors: John H. Cochrane
Abstract: I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of "bad times," rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets' tendency to pay off poorly in "bad times." I survey the literature, covering the time-series and cross-sectional facts, the equity premium, consumption-based models, general equilibrium models, and labor income/idiosyncratic risk approaches.
Keywords: Financial Markets; Macroeconomics; Risk Premia
JEL Codes: G1; E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| marginal value of wealth (vw) (E21) | expected excess return (ere) (G17) |
| covariance of asset returns with marginal value of wealth (covt(rt−1, vw)) (G19) | expected excess return (ere) (G17) |
| covariance of asset returns with marginal value of wealth (covt(rt−1, vw)) (G19) | covariance of returns with the discount factor (covt(rt−1, discount factor)) (E43) |
| positive covariance of asset payoffs with marginal utility (G19) | higher prices for those assets (G19) |
| higher prices for assets (G19) | lower average returns (G19) |
| high volatility of marginal value of wealth (G19) | equity premium puzzle (G12) |
| low risk aversion and observed consumption volatility (D11) | equity premium puzzle (G12) |