The Time Variation in Risk Appetite and Uncertainty

Geert Bekaert, Eric C. Engstrom () and Nancy R. Xu ()
Additional contact information
Eric C. Engstrom: Research and Statistics Division, Federal Reserve Board, Washington, District of Columbia 20551
Nancy R. Xu: Finance Department, Carroll School of Management, Boston College, Chestnut Hill, Massachusetts 02467

Management Science, 2022, vol. 68, issue 6, 3975-4004

Abstract: We formulate a dynamic no-arbitrage asset pricing model for equities and corporate bonds, featuring time variation in both risk aversion and economic uncertainty. The joint dynamics among cash flows, macroeconomic fundamentals, and risk aversion accommodate both heteroskedasticity and non-Gaussianity. The model delivers measures of risk aversion and uncertainty at the daily frequency. We verify that equity variance risk premiums are very informative about risk aversion, whereas credit spreads and corporate bond volatility are highly correlated with economic uncertainty. Our model-implied risk premiums outperform standard instruments for predicting asset excess returns. Risk aversion is substantially correlated with consumer confidence measures and in early 2020 reacted more strongly to new COVID cases than did an uncertainty proxy.

Keywords: risk aversion; economic uncertainty; dynamic asset pricing model; VIX; variance risk premium; sentiment; COVID crisis (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (61)

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http://dx.doi.org/10.1287/mnsc.2021.4068 (application/pdf)

Related works:
Working Paper: The Time Variation in Risk Appetite and Uncertainty (2019)
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