A LINKAGE BETWEEN THE FINANCIAL AND THE REAL ECONOMY

Sebastian Rey

Annals of Financial Economics (AFE), 2022, vol. 17, issue 03, 1-33

Abstract: The aim of this paper is to present a linkage between the real economy (micro and macro) and the financial economy. This relationship is obtained from the non-arbitrage valuation of equities framework. The paper also investigates if this theoretical relationship is actually observed. For this purpose, it proposes and tests an empirical model for excess returns that includes the linkage as a crucial element. The actual observation of the linkage could be of special importance for the financial economics discipline, since it presents several features that are not usually seen in other asset pricing or macro-finance models: (a) the relationship is explicit and does not depend on the estimation of free parameters; (b) it is derived under arbitrage free arguments and does not introduce subjective concepts as utility function or risk aversion; and (c) it explains the observed level of equity risk premium without entering in contradiction with its theoretical foundations. The conclusions of the performed tests are in favor of the concepts provided by the framework, meaning that further research could offer an alternative understanding of the behavior of financial markets and their connection with the real economy.

Keywords: Asset pricing; arbitrage-free pricing; excess returns; equity premium puzzle; macro-finance (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1142/S201049522250021X

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