Expectations and Aggregate Risk
55 Pages Posted: 14 Dec 2013 Last revised: 24 Aug 2023
Date Written: April 30, 2020
We estimate agents’ expectations about future fundamentals using a dynamic stochastic general equilibrium model augmented with anticipated 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. Further, exposure to macroeconomic fluctuations driven purely by expectations is important to explain the value premium. In contrast, exposure to macroeconomic fluctuations due to realized changes in fundamentals is important for the pricing of long-term bonds and cash-flow duration portfolios. We conclude that accounting for agents’ expectations advances our understanding of the aggregate risk.
Keywords: News Shocks, Consumption-CAPM, Cross Section of Returns, Market-to-Book Decomposition
JEL Classification: G12, E32, E21, C63
Suggested Citation: Suggested Citation