Risk, Uncertainty and Asset Prices

57 Pages Posted: 3 Jan 2007

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

Yuhang Xing

Rice University

Multiple version iconThere are 4 versions of this paper

Date Written: November 2006

Abstract

We identify the relative importance of changes in the conditional variance of fundamentals (which we call "uncertainty") and changes in risk aversion ("risk" for short) in the determination of the term structure, equity prices and risk premiums. Theoretically, we introduce persistent time-varying uncertainty about the fundamentals in an external habit model. The model matches the dynamics of dividend and consumption growth, including their volatility dynamics and many salient asset market phenomena. While the variation in dividend yields and the equity risk premium is primarily driven by risk, uncertainty plays a large role in the term structure and is the driver of counter-cyclical volatility of asset returns.

Keywords: Equity premium, uncertainty, stochastic risk aversion, time variation in risk and return, excess volatility, external habit, term structure

JEL Classification: E44, G12, G15

Suggested Citation

Bekaert, Geert and Engstrom, Eric C. and Xing, Yuhang, Risk, Uncertainty and Asset Prices (November 2006). CEPR Discussion Paper No. 5947. Available at SSRN: https://ssrn.com/abstract=954707

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)

Yuhang Xing

Rice University ( email )

6100 South Main Street
Houston, TX 7705-1892
United States

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