Investor Information, Long-Run Risk, and the Duration of Risky Cash Flows

59 Pages Posted: 26 Feb 2007

See all articles by Mariano (Max) Massimiliano Croce

Mariano (Max) Massimiliano Croce

Finance Department, Bocconi University; Centre for Economic Policy Research (CEPR)

Martin Lettau

University of California - Haas School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Sydney C. Ludvigson

New York University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: March 14, 2008

Abstract

We study the role of information in asset pricing models with long-run cash flow risk. To illustrate the importance of the information structure, we show how the implications of the long-run risk paradigm for the cross-sectional properties of stock returns and cash flow duration are affected by information. When investors can fully distinguish short- and long-run consumption risk components of dividend growth innovations (full information), only exposure to long-run consumption risk generates significant risk premia, implying that high-return value stocks are long-duration assets, contrary to the historical data. By contrast, when investors observe the change in consumption and dividends each period but not the individual components of that change (limited information), exposure to short-run risk can generate large risk premia, so that high-return value stocks are short-duration assets while low-return growth stocks are long-duration assets, as in the data. We also show that, in order to explain empirical finding that long-horizon equity is less risky than short-horizon equity, the properties of the cash flow model and the values of primitive preference parameters must be quite different from those emphasized in the existing long-run risk literature.

JEL Classification: G10, G12

Suggested Citation

Croce, Mariano Massimiliano and Lettau, Martin and Ludvigson, Sydney C., Investor Information, Long-Run Risk, and the Duration of Risky Cash Flows (March 14, 2008). AFA 2008 New Orleans Meetings, AFA 2009 San Francisco Meetings Paper, Available at SSRN: https://ssrn.com/abstract=960886

Mariano Massimiliano Croce

Finance Department, Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

HOME PAGE: http://sites.google.com/view/mmcroce/home

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Martin Lettau

University of California - Haas School of Business ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States
5106436349 (Phone)

HOME PAGE: http://faculty.haas.berkeley.edu/lettau/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Sydney C. Ludvigson (Contact Author)

New York University - Department of Economics ( email )

19 West 4th Street, 6th floor
New York, NY 10012
United States
212-998-8927 (Phone)
212-995-4186 (Fax)

HOME PAGE: http://www.econ.nyu.edu/user/ludvigsons/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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