Investor Information, Long-Run Risk, and the Term Structure of Equity

Mariano Croce, Martin Lettau and Sydney Ludvigson

No 12912, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study the role of information in asset pricing models with long-run cash flow risk. When investors can distinguish short- from long-run consumption risks (full information), the model generates a sizable equity risk premium only if the equity term structure slopes up, contrary to the data. In general, the short- and long-run components are unidentified. We propose a sparsity-based bounded rationality model of long-run risk that is both parsimonious and fully identified from historical data. In contrast to full information, the model generates a sizable market risk premium simultaneously with a downward sloping equity term structure, as in the data.

JEL-codes: E44 G10 G12 (search for similar items in EconPapers)
Date: 2007-02
New Economics Papers: this item is included in nep-cfn and nep-mac
Note: AP
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Citations: View citations in EconPapers (44)

Published as Mariano M. Croce & Martin Lettau & Sydney C. Ludvigson, 2015. "Investor Information, Long-Run Risk, and the Term Structure of Equity," Review of Financial Studies, Society for Financial Studies, vol. 28(3), pages 706-742.

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Journal Article: Investor Information, Long-Run Risk, and the Term Structure of Equity (2015)
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