Asset Pricing with Persistence Risk
Review of Financial Studies, Forthcoming
61 Pages Posted: 7 Sep 2017 Last revised: 21 Nov 2018
Date Written: November 16, 2018
Persistence risk is an endogenous source of risk that arises when a rational agent learns about the length of business cycles. Persistence risk is positive during recessions and negative during expansions. This asymmetry, which solely results from learning about persistence, causes expected returns, return volatility, and the price of risk to rise during recessions. Persistence risk predicts future excess returns, particularly at 3- to 7-year horizons. Its predictability is strongest around business-cycle peaks and troughs. We confirm the model's predictions in the data and provide evidence that persistence risk is priced in financial markets.
Keywords: persistence risk, learning, long-run risk
JEL Classification: G12
Suggested Citation: Suggested Citation