Working Paper: NBER ID: w15688
Authors: Ralph SJ Koijen; Hanno Lustig; Stijn Van Nieuwerburgh
Abstract: Value stocks have higher exposure to innovations in the nominal bond risk premium, which measures the markets' perception of cyclical variation in future output growth, than growth stocks. The ICAPM then predicts a value risk premium provided that good news about future output lowers the marginal utility of investors' wealth today. In support of the business cycle as a priced state variable, we show that low value minus growth returns, typically realized at the start of recessions when nominal bond risk premia are low and declining, are associated with lower future dividend growth rates on value minus growth and with lower future output growth in the short term. Because of this new nexus between stock and bond returns, a parsimonious three-factor model can jointly price the book-to-market stock and maturity-sorted bond portfolios and reproduce the time-series variation in expected bond returns. Structural dynamic asset pricing models need to impute a central role to the business cycle as a priced state variable to be quantitatively consistent with the observed value, equity, and nominal bond risk premia.
Keywords: stock returns; bond returns; value premium; business cycle; asset pricing
JEL Codes: E21; E43; G00; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| economic cycle (E32) | stock performance (G12) |
| economic conditions (E66) | asset returns (G19) |
| bond market conditions (E43) | stock returns (G12) |
| innovations in bond market factors (G10) | marginal utility of wealth (D11) |
| low CP or Y_sp factors (C23) | future dividend growth rates on value minus growth portfolios (G35) |
| innovations in bond market factors (G10) | marginal utility of wealth for investors (E21) |