Financial Market Risk Perceptions and the Macroeconomy
66 Pages Posted: 22 Nov 2016 Last revised: 6 Sep 2019
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Financial Market Risk Perceptions and the Macroeconomy
Financial Market Risk Perceptions and the Macroeconomy
Date Written: September 4, 2019
Abstract
We propose a novel measure of risk perceptions: the price of volatile stocks (PVSt), defined as the book-to-market ratio of low-volatility stocks minus the book-to-market ratio of high-volatility stocks. PVSt is high when perceived risk directly measured from surveys and option prices is low. When perceived risk is high according to our measure, safe asset prices are high, risky asset prices are low, the cost of capital for risky firms is high, and real investment is forecast to decline. Perceived risk as measured by PVSt falls after positive macroeconomic news. These declines are predictably followed by upward revisions in investor risk perceptions. Our results suggest that risk perceptions embedded in stock prices are an important driver of the business cycle and are not fully rational.
Keywords: risk-centric business cycles, cross-section of equities, real risk-free rate, real investment
JEL Classification: E120, E220, E430, E440, G120, G400
Suggested Citation: Suggested Citation