Long-Run Risk Is the Worst-Case Scenario

Rhys Bidder and Ian Dew-Becker

American Economic Review, 2016, vol. 106, issue 9, 2494-2527

Abstract: We study an investor who is unsure of the dynamics of the economy. Not only are parameters unknown, but the investor does not even know what order model to estimate. She estimates her consumption process nonparametrically--allowing potentially infinite-order dynamics--and prices assets using a pessimistic model that minimizes lifetime utility subject to a constraint on statistical plausibility. The equilibrium is exactly solvable and the pricing model always includes long-run risks. With risk aversion of 4.7, the model matches major facts about asset prices, consumption, and dividends. The paper provides a novel link between ambiguity aversion and nonparametric estimation.

JEL-codes: D11 D12 D81 G11 G12 (search for similar items in EconPapers)
Date: 2016
Note: DOI: 10.1257/aer.20150585
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Citations: View citations in EconPapers (22)

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Working Paper: Long-Run Risk is the Worst-Case Scenario (2016)
Working Paper: Long-Run Risk is the Worst-Case Scenario (2015)
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