Stock and Bond Returns with Moody Investors

65 Pages Posted: 18 Aug 2004

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

Steven R. Grenadier

Stanford Graduate School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: November 2006

Abstract

We present a tractable, linear model for the simultaneous pricing of stock and bond returns that incorporates stochastic risk aversion. In this model, analytic solutions for endogenous stock and bond prices and returns are readily calculated. After estimating the parameters of the model by the general method of moments, we investigate a series of classic puzzles of the empirical asset pricing literature. In particular, our model is shown to jointly accommodate the mean and volatility of equity and long term bond risk premia as well as salient features of the nominal short rate, the dividend yield, and the term spread. Also, the model matches the evidence for predictability of excess stock and bond returns. However, the stock-bond return correlation implied by the model is somewhat higher than in the data.

Keywords: Equity premium, excess volatility, stock-bond return correlation, return predictability, countercyclical risk aversion, habit persistence

JEL Classification: E44, G12, G15

Suggested Citation

Bekaert, Geert and Engstrom, Eric C. and Grenadier, Steven R., Stock and Bond Returns with Moody Investors (November 2006). CEPR Discussion Paper No. 5951. Available at SSRN: https://ssrn.com/abstract=578122

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)

Steven R. Grenadier

Stanford Graduate School of Business ( email )

Graduate School of Business
Stanford, CA 94305-5015
United States
650-725-0706 (Phone)
650-725-6152 (Fax)

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