News, Beliefs, and Aggregate Risk
62 Pages Posted: 14 Dec 2013 Last revised: 16 Oct 2019
Date Written: March 28, 2019
We examine the role of agents’ expectations about future economic fundamentals for the identification of aggregate risk. To this end, we estimate a New-Keynesian general equilibrium model augmented with expectation, or news, shocks. Accounting for agents’ expectations at the business cycle horizon results in aggregate risk factor innovations that have significant explanatory power for the cross section of stock and bond returns. In particular, news offer a novel explanation for the value premium consistent with the role of the market-to-value component of the value strategy returns. Moreover, news are important to price cash-flow duration sorted portfolios.
Keywords: News Shocks, Consumption-CAPM, Cross Section of Returns, Market-to-Book Decomposition
JEL Classification: G12, E32, E21, C63
Suggested Citation: Suggested Citation