Working Paper: NBER ID: w18104
Authors: Ravi Bansal; Dana Kiku; Ivan Shaliastovich; Amir Yaron
Abstract: We show that volatility movements have first-order implications for consumption dynamics and asset prices. Volatility news affects the stochastic discount factor and carries a separate risk premium. In the data, volatility risks are persistent and are strongly correlated with discount-rate news. This evidence has important implications for the return on aggregate wealth and the cross-sectional differences in risk premia. Estimation of our volatility risks based model yields an economically plausible positive correlation between the return to human capital and equity, while this correlation is implausibly negative when volatility risk is ignored. Our model setup implies a dynamics capital asset pricing model (DCAPM) which underscores the importance of volatility risk in addition to cash-flow and discount-rate risks. We show that our DCAPM accounts for the level and dispersion of risk premia across book-to-market and size sorted portfolios, and that equity portfolios carry positive volatility-risk premia.
Keywords: volatility; macroeconomy; asset prices
JEL Codes: E0; G0; G1; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| volatility (E32) | consumption dynamics (E21) |
| volatility (E32) | asset prices (G19) |
| volatility (E32) | stochastic discount factor (SDF) (D15) |
| stochastic discount factor (SDF) (D15) | risk and return (G11) |
| volatility (E32) | expected consumption (D12) |
| volatility (E32) | risk premia (G22) |
| volatility (E32) | correlation between human capital returns and equity returns (J24) |
| ignoring volatility risks (G17) | misestimation of the SDF (C13) |