Expectations and Aggregate Risk

66 Pages Posted: 14 Dec 2013 Last revised: 30 Apr 2020

See all articles by Lorenzo Bretscher

Lorenzo Bretscher

London Business School - Department of Finance

Aytek Malkhozov

Board of Governors of the Federal Reserve System

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Date Written: April 30, 2020

Abstract

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

Bretscher, Lorenzo and Malkhozov, Aytek and Tamoni, Andrea, Expectations and Aggregate Risk (April 30, 2020). Available at SSRN: https://ssrn.com/abstract=2367196 or http://dx.doi.org/10.2139/ssrn.2367196

Lorenzo Bretscher

London Business School - Department of Finance ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

Aytek Malkhozov

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Andrea Tamoni (Contact Author)

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

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