Macroeconomic shocks and risk premia
LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library
What are the macroeconomic forces behind the cross-sectional and time-series variation in expected excess returns? To answer this question, this paper integrates models of empirical asset pricing with structural vector autoregressions (VAR). First, I use an unconditional asset pricing framework to construct 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)
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Working Paper: Macroeconomic Shocks and Risk Premia (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:90370
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