Macroeconomic Tail Risks and Asset Prices

David Schreindorfer and Stijn Van Nieuwerburgh

The Review of Financial Studies, 2020, vol. 33, issue 8, 3541-3582

Abstract: I document that dividend growth and returns on the aggregate U.S. stock market are more correlated with consumption growth in bad economic times. In a consumption-based asset pricing model with a generalized disappointment-averse investor and small, IID consumption shocks, this feature results in a realistic equity premium despite low risk aversion. The model is consistent with the main facts about stock market risk premiums inferred from equity index options, remains tightly parameterized, and allows for analytical solutions for asset prices. An extension with non-IID dynamics accounts for excess volatility and return predictability, while preserving the model’s consistency with option moments.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Date: 2020
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