Working Paper: NBER ID: w26290
Authors: Carolin Pflueger; Emil Siriwardane; Adi Sunderam
Abstract: We propose a novel measure of risk perceptions: the price of volatile stocks (PVSₜ), defined as the book-to-market ratio of low-volatility stocks minus the book-to-market ratio of high-volatility stocks. PVSₜ is high when perceived risk directly measured from surveys and option prices is low. When perceived risk is high according to our measure, safe asset prices are high, risky asset prices are low, the cost of capital for risky firms is high, and real investment is forecast to decline. Perceived risk as measured by PVSₜ falls after positive macroeconomic news. These declines are predictably followed by upward revisions in investor risk perceptions. Our results suggest that risk perceptions embedded in stock prices are an important driver of the business cycle and are not fully rational.
Keywords: Risk Perception; Macroeconomy; Investment; Financial Markets
JEL Codes: E03; E22; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low perceived risk (D81) | economic expansions (E32) |
| recent economic events (E65) | perceived risk (pvst) (D81) |
| perceived risk (pvst) (D81) | risk expectations (D81) |
| perceived risk (pvst) (D81) | real interest rates (E43) |
| perceived risk (pvst) (D81) | real investment (E22) |
| perceived risk (pvst) (D81) | output (C67) |
| perceived risk (pvst) (D81) | employment (J68) |