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Macroeconomic Shocks and Risk Premia

Gabor Pinter

No 1812, Discussion Papers from Centre for Macroeconomics (CFM)

Abstract: This paper integrates models of empirical asset pricing with structural vector autoregressions (VAR) to explore the macroeconomic forces behind the cross-sectional and time-series variation in expected excess returns. First, I use an unconditional asset pricing framework to find an orthogonal shock in a macroeconomic VAR that best explains the cross-sectional variation in expected returns. The obtained “λ-shock” closely resembles identified monetary policy surprises and does not explain the recent US recessions. Second, I integrate return-forecasting methods to construct a second shock in the VAR, which best explains time-variation in expected returns. The obtained “γ-shock” turns out to be virtually orthogonal to the λ-shock, closely resembles demand-type financial shocks identified by macroeconomists, and explains most US recessions. I find that the λ-shock and the γ-shock jointly explain up to 80% of aggregate consumption fluctuations in the US.

Keywords: SDF; VAR; Shocks; Cross-section of returns; Time-varying risk premia (search for similar items in EconPapers)
JEL-codes: C32 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2018-05
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