Macroeconomic Drivers of Bond and Equity Risks

55 Pages Posted: 29 Sep 2013 Last revised: 15 May 2019

See all articles by John Y. Campbell

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Carolin E. Pflueger

University of British Columbia (UBC) - Division of Finance; National Bureau of Economic Research (NBER)

Luis M. Viceira

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 13, 2019

Abstract

Our new model of consumption-based habit generates time-varying risk premia on bonds and stocks from loglinear, homoskedastic macroeconomic dynamics. Consumers' first-order condition for the real risk-free bond generates an exactly loglinear consumption Euler equation, commonly assumed in New Keynesian models. We estimate that the correlation between inflation and the output gap switched from negative to positive in 2001. Higher inflation lowers real bond returns and higher output raises stock returns, explaining why the bond-stock return correlation changed from positive to negative. In the model risk premia amplify this change in bond-stock return comovement, and are crucial for a quantitative explanation.

Keywords: consumption-based habit formation; consumption Euler equation; time-varying risk premia; inflation dynamics; bond-stock correlation

JEL Classification: E3, E4, G12

Suggested Citation

Campbell, John Y. and Pflueger, Carolin E. and Viceira, Luis M., Macroeconomic Drivers of Bond and Equity Risks (May 13, 2019). Harvard Business School Finance Working Paper No. 14-031. Available at SSRN: https://ssrn.com/abstract=2332106 or http://dx.doi.org/10.2139/ssrn.2332106

John Y. Campbell

Harvard University - Department of Economics ( email )

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HOME PAGE: http://scholar.harvard.edu/campbell

National Bureau of Economic Research (NBER)

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Carolin E. Pflueger

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

National Bureau of Economic Research (NBER) ( email )

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Luis M. Viceira (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6331 (Phone)
617-496-6592 (Fax)

HOME PAGE: http://www.people.hbs.edu/lviceira

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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