The Real Response to Uncertainty Shocks: The Risk Premium Channel

Lorenzo Bretscher (), Alex Hsu () and Andrea Tamoni ()
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Lorenzo Bretscher: Department of Finance, University of Lausanne, Swiss Finance Institute, Centre of Economic Policy Research, 1015, Lausanne, Switzerland
Alex Hsu: Scheller College of Business, Georgia Institute of Technology, Atlanta, Georgia 30308
Andrea Tamoni: Department of Finance and Economics, Rutgers Business School, Newark, New Jersey 07102

Management Science, 2023, vol. 69, issue 1, 119-140

Abstract: Uncertainty shocks are also risk premium shocks. With countercyclical risk aversion (RA), a positive shock to uncertainty increases risk and elevates RA as consumption growth falls. The combination of high RA and high uncertainty produces significant equity risk premia in bad times, which in turn, exacerbate the decline of macroeconomic aggregates and equity prices. Moreover, in the cross-section of equity returns, investors demand a risk premium for stocks that perform poorly in times of high uncertainty and elevated risk aversion. In a model with endogenously time-varying RA, uncertainty shocks lead to large falls in investment and equity prices that closely match state-dependent data responses.

Keywords: risk aversion; uncertainty; conditional IRF; dynamic economies (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:69:y:2023:i:1:p:119-140

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