The Market Price of Risk and Macro-Financial Dynamics

Tobias Adrian, Matthew DeHaven, Fernando Duarte and Tara Iyer

No 22106, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We estimate the component of the market price of risk spanned by asset returns using a model with non-separable preferences, incomplete markets, and frictions. This return-spanned price of risk predicts the conditional mean and volatility of GDP growth and comoves with financial conditions. We identify its shocks through heteroskedasticity and find large, persistent macroeconomic effects. Our Volatility Financial Conditions Index (VFCI), the return-predicted conditional volatility of GDP growth, closely tracks this price of risk and forecasts growth. Tightening VFCI shocks lower output and prompt monetary easing. Contractionary monetary shocks tighten financial conditions.

Keywords: Macro-finance; Monetary policy; Financial conditions; Growth-at-Risk; Consumption volatility; Market price of risk (search for similar items in EconPapers)
JEL-codes: E44 E52 G12 (search for similar items in EconPapers)
Date: 2026-10
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