The Resolution of Long-Run Risk

Abstract

Long-run risk models, a cornerstone in the macro-finance literature for their ability to capture key asset price phenomena, are known to entail implausibly high levels of timing and risk premia. Our paper resolves this puzzle by considering consumption of durable goods in addition to that of non-durable goods. In our estimated model, the timing premium is 11 percent and the risk premium is 16 percent of lifetime consumption. These values are about a third of the previously implied premia and are more consistent with empirical and experimental evidence.

Keywords: Durable Goods, Long-Run Risk Models, Particle Filtering, Timing and Risk Premium

JEL Classification: C11, E21, G11, G12