The Time Variation in Risk Appetite and Uncertainty

78 Pages Posted: 26 Mar 2019

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

Eric Engstrom

U.S. Board of Governors of the Federal Reserve System - Division of Research and Statistics, Capital Markets

Nancy R. Xu

Boston College, Carroll School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: March 2019

Abstract

We develop measures of time-varying risk aversion and economic uncertainty that are calculated from financial variables at high frequencies. We formulate a dynamic no-arbitrage asset pricing model for equities and corporate bonds. The joint dynamics among asset-specific cash flows, macroeconomic fundamentals and risk aversion feature heteroskedasticity and non-Gaussianity. Variance risk premiums on equity are very informative about risk aversion, whereas credit spreads and corporate bond volatility are highly correlated with economic uncertainty. Model-implied risk premiums outperform standard instruments for predicting excess returns on equity and corporate bonds. A financial proxy to our economic uncertainty predicts output growth significantly negatively.

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Suggested Citation

Bekaert, Geert and Engstrom, Eric C. and Xu, Nancy R., The Time Variation in Risk Appetite and Uncertainty (March 2019). NBER Working Paper No. w25673. Available at SSRN: https://ssrn.com/abstract=3359430

Geert Bekaert (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Eric C. Engstrom

U.S. Board of Governors of the Federal Reserve System - Division of Research and Statistics, Capital Markets ( email )

20th & C. St., N.W.
Washington, DC 20551
United States
202-452-3044 (Phone)

Nancy R. Xu

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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