Expectations and Aggregate Risk

Lorenzo Bretscher, Aytek Malkhozov and Andrea Tamoni
Additional contact information
Lorenzo Bretscher: London Business School - Department of Finance
Aytek Malkhozov: Board of Governors of the Federal Reserve System
Andrea Tamoni: Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

No 21-68, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We estimate agents’ expectations about future fundamentals using a dynamic stochastic general equilibrium model augmented with anticipated shocks. Accounting for agents’ expectations at the business cycle horizon results in aggregate risk factor innovations that have significant explanatory power for the cross section of stock and bond returns. Further, exposure to macroeconomic fluctuations driven purely by expectations is important to explain the value premium. In contrast, exposure to macroeconomic fluctuations due to realized changes in fundamentals is important for the pricing of long-term bonds and cash-flow duration portfolios. We conclude that accounting for agents’ expectations advances our understanding of the aggregate risk.

Keywords: News Shocks; Consumption-CAPM; Cross Section of Returns; Market-to-Book Decomposition (search for similar items in EconPapers)
JEL-codes: C63 E21 E32 G12 (search for similar items in EconPapers)
Pages: 68 pages
Date: 2021-10
New Economics Papers: this item is included in nep-cwa, nep-dge, nep-mac, nep-ore and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2168

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