 On the systematic volatility of unpriced earningsTimothy C. Johnson and Jaehoon Lee Journal of Financial Economics, 2014, vol. 114, issue 1, 84-104 Abstract: Some important puzzles in macro finance can be resolved in a model featuring systematically varying volatility of unpriced shocks to firms׳ earnings. In the data, the correlation between corporate debt and stock market valuations is low. The model accounts for this via the opposing effect of unpriced earnings risk on levered debt and equity prices. The model also explains the low (or nonexistent) risk-reward relation for the market portfolio of levered equity via the opposing effects of unpriced and priced uncertainty (both components of stock volatility) on the levered equity risk premium. Versions of the model calibrated to empirical measures of both types of fundamental risk can quantitatively substantiate these explanations. Variation in residual earning dispersion accounts for a significant fraction of observed disagreement between debt and equity valuations and of realized stock volatility. The implication that the two components of risk should forecast the levered equity risk premium with opposite signs is also supported in the data. The results are a notable advance for risk-based asset pricing. Keywords: Credit spreads; Equity premium; Volatility components (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:114:y:2014:i:1:p:84-104 DOI: 10.1016/j.jfineco.2014.05.012 Access Statistics for this article Journal of Financial Economics is currently edited by G. William Schwert More articles in Journal of Financial Economics from Elsevier |
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