Working Paper: NBER ID: w18617
Authors: Rui Albuquerque; Martin S. Eichenbaum; Sergio Rebelo
Abstract: Standard representative-agent models fail to account for the weak correlation between stock returns and measurable fundamentals, such as consumption and output growth. This failing, which underlies virtually all modern asset-pricing puzzles, 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: Asset Pricing; Valuation Risk; Equity 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) | asset pricing moments (G19) |
| demand shocks (E39) | expected returns on assets (G12) |
| valuation risk (G32) | expected returns on assets (G12) |
| valuation risk (G32) | equity premium (G12) |
| volatility of time-preference shocks (D15) | expected equity premium (G12) |
| lagged price-dividend ratios (G35) | excess returns (D46) |