The Time Variation in Risk Appetite and Uncertainty

47 Pages Posted: 14 Nov 2017 Last revised: 11 Feb 2021

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

Eric Engstrom

Board of Governors of the Federal Reserve System

Nancy R. Xu

Boston College, Carroll School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: February 10, 2021

Abstract

We formulate a dynamic no-arbitrage asset pricing model for equities and corporate bonds, featuring time variation in both risk aversion and economic uncertainty. The joint dynamics among cash flows, macroeconomic fundamentals and risk aversion accommodate both heteroskedasticity and non-Gaussianity. The model delivers measures of risk aversion and uncertainty at the daily frequency. We verify that equity variance risk premiums are very informative about risk aversion, whereas credit spreads and corporate bond volatility are highly correlated with economic uncertainty. Our model-implied risk premiums outperform standard instruments for predicting asset excess returns. Risk aversion is substantially correlated with consumer confidence measures, and in early 2020 reacted more strongly to new Covid cases than did an uncertainty proxy.

Keywords: Risk aversion, Economic uncertainty, Dynamic asset pricing model, VIX, Variance risk premium, Sentiment, Covid crisis.

JEL Classification: C1, G10, G12, G13

Suggested Citation

Bekaert, Geert and Engstrom, Eric C. and Xu, Nancy R., The Time Variation in Risk Appetite and Uncertainty (February 10, 2021). Columbia Business School Research Paper No. 17-108, 31st Australasian Finance and Banking Conference 2018, American Finance Association Annual Meeting 2019, Available at SSRN: https://ssrn.com/abstract=3069078 or http://dx.doi.org/10.2139/ssrn.3069078

Geert Bekaert

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Eric C. Engstrom

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-3044 (Phone)

Nancy R. Xu (Contact Author)

Boston College, Carroll School of Management ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

HOME PAGE: http://www.nancyxu.net

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