Learning about the Consumption Risk Exposure of Firms
63 Pages Posted: 4 Aug 2021 Last revised: 29 Nov 2023
Date Written: August 1, 2021
We structurally estimate an investment-based asset pricing model, in which firms' exposure to macroeconomic risk is unknown. Bayesian beliefs about this parameter are updated from firms' and industry peers' comovement between their productivity and consumption growth. The model implies that discount rates rise endogenously with the perceived risk exposure of firms, thereby depressing investment and valuation ratios. We test these predictions in the data and find strong support for them. We also confirm that cross-sectional learning from peers is crucial, and that alternative Bayesian risk estimates, which ignore peer observations, do not predict firm variables.
Keywords: Parameter uncertainty, Bayesian learning, Systematic consumption risk, Investment-based asset pricing, SMM
JEL Classification: E2, E3, G12
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