Macroeconomic Risks and Asset Pricing: Evidence from a Dynamic Stochastic General Equilibrium Model

47 Pages Posted: 8 Jun 2017 Last revised: 26 Jan 2018

See all articles by Erica X. N. Li

Erica X. N. Li

Cheung Kong Graduate School of Business

Haitao Li

Cheung Kong Graduate School of Business

Shujing Wang

Tongji University

Cindy Yu

Iowa State University

Date Written: June 6, 2017

Abstract

We study the relation between macroeconomic fundamentals and asset pricing through the lens of a dynamic stochastic general equilibrium (DSGE) model. We provide full-information Bayesian estimation of the DSGE model using macroeconomic variables and extract the time-series of four latent fundamental shocks of the model: neutral technology shock, investment-specific technological shock, monetary policy shock, and risk shock. Asset pricing tests show that our model-implied four-factor model can explain a number of prominent cross-sectional return spreads: size, book-to-market, investment, earnings, and long-term reversal. The investment-specific technological shock and risk shock play the most important role in explaining those return spreads.

Keywords: DSGE model, Bayesian MCMC estimation, stock returns, neutral technology shock, investment-specific technology shock, monetary policy shock, risk shock

JEL Classification: C11, C13, E44

Suggested Citation

Li, Erica X. N. and Li, Haitao and Wang, Shujing and Yu, Cindy, Macroeconomic Risks and Asset Pricing: Evidence from a Dynamic Stochastic General Equilibrium Model (June 6, 2017). Available at SSRN: https://ssrn.com/abstract=2982181 or http://dx.doi.org/10.2139/ssrn.2982181

Erica X. N. Li (Contact Author)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Haitao Li

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Shujing Wang

Tongji University ( email )

Shanghai
China

Cindy Yu

Iowa State University ( email )

613 Wallace Road
Ames, IA 50011
United States

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