Financial Market Risk Perceptions and the Macroeconomy

66 Pages Posted: 22 Nov 2016 Last revised: 6 Sep 2019

See all articles by Carolin E. Pflueger

Carolin E. Pflueger

University of Chicago - Harris Public Policy; National Bureau of Economic Research (NBER)

Emil Siriwardane

Harvard Business School - Finance Unit; Office of Financial Research

Adi Sunderam

Harvard Business School

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

Pflueger, Carolin E. and Siriwardane, Emil and Sunderam, Adi, Financial Market Risk Perceptions and the Macroeconomy (September 4, 2019). Harvard Business School Finance Working Paper No. 17-040. Available at SSRN: https://ssrn.com/abstract=2873688 or http://dx.doi.org/10.2139/ssrn.2873688

Carolin E. Pflueger

University of Chicago - Harris Public Policy ( email )

1155 East 60th Street
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Emil Siriwardane (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States

Office of Financial Research ( email )

717 14th Street, NW
Washington DC, DC 20005
United States

Adi Sunderam

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
372
Abstract Views
1,637
rank
79,233
PlumX Metrics