Cash flow and risk premium dynamics in an equilibrium asset-pricing model with recursive preferences

Taeyoung Doh and Shu Wu

No RWP 15-12, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: Under linear approximations for asset prices and the assumption of independence between expected consumption growth and time-varying volatility, long-run risks models imply constant market prices of risks and often generate counterfactual results about asset return and cash ?ow predictability. We develop and estimate a nonlinear equilibrium asset pricing model with recursive preferences and a ?exible econometric speci?cation of cash ?ow processes. While in many long-run risks models time-varying volatility in?uences only risk premium but not expected cash ?ows, in our model a common set of risk factors drive both expected cash ?ow and risk premium dynamics. This feature helps the model to overcome two main criticisms against long-run risk models following Bansal and Yaron (2004): the over-predictability of cash ?ows by asset prices and the tight relation between time-varying risk premia and growth volatility. Our model extends the approach in Le and Singleton (2010) to a setting with multiple cash ?ows. We estimate the model using the long-run historical data in the U.S. and ?nd that the model with generalized market prices of risks produces cash ?ow and return predictability that are more consistent with the data.

Keywords: Recursive preferences; Consumption risks (search for similar items in EconPapers)
JEL-codes: E21 G12 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2015-10-01
New Economics Papers: this item is included in nep-mac and nep-upt
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