Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles

43 Pages Posted: 15 Dec 2000 Last revised: 9 Jan 2022

See all articles by Ravi Bansal

Ravi Bansal

Duke University and NBER

Amir Yaron

University of Pennsylvania -- Wharton School of Business; Bank of Israel; National Bureau of Economic Research (NBER)

Date Written: December 2000

Abstract

We model dividend and consumption growth rates as containing a small long-run predictable component and economic uncertainty (i.e., growth rate volatility) as being time-varying. The magnitudes of the predictable variation and changing volatility in growth rates, as in the data, are quite small. These growth rate dynamics, for which we provide empirical support, in conjunction with plausible parameter configurations of the Epstein and Zin (1989) preferences can explain key observed asset markets phenomena. In particular, we show that the model can justify the observed equity premium, the low risk free rate, and the ex-post volatilities of the market return, real risk free rate, and the price-dividend ratio. As in the data, the model also implies that dividend yields predict returns and that market return volatility is stochastic. The main economic insight we capture is that news about growth rates significantly alter agent's perceptions regarding long run expected growth rates and growth rate uncertainty--in equilibrium, this leads to a large equity risk premium, low risk free interest rate, and large market volatility.

Suggested Citation

Bansal, Ravi and Yaron, Amir and Yaron, Amir, Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles (December 2000). NBER Working Paper No. w8059, Available at SSRN: https://ssrn.com/abstract=254020

Ravi Bansal (Contact Author)

Duke University and NBER ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7758 (Phone)
919-660-8038 (Fax)

Amir Yaron

Bank of Israel

P.O. Box 780
Jerusalem, 91907
Israel

University of Pennsylvania -- Wharton School of Business ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-1241 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States