Long-Run Risk is the Worst-Case Scenario

Rhys Bidder and Ian Dew-Becker

No 22416, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study an investor who is unsure of the dynamics of the economy. Not only are parameters unknown, but the investor does not even know what order model to estimate. She estimates her consumption process nonparametrically – allowing potentially infinite-order dynamics – and prices assets using a pessimistic model that minimizes lifetime utility subject to a constraint on statistical plausibility. The equilibrium is exactly solvable and we show that the pricing model always includes long-run risks. With risk aversion of 4.7, the model matches major facts about asset prices, consumption, and dividends. The paper provides a novel link between ambiguity aversion and non-parametric estimation.

JEL-codes: C14 D83 D84 G12 (search for similar items in EconPapers)
Date: 2016-07
New Economics Papers: this item is included in nep-ore, nep-rmg and nep-upt
Note: AP EFG
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Citations: View citations in EconPapers (25)

Published as Rhys Bidder & Ian Dew-Becker, 2016. "Long-Run Risk Is the Worst-Case Scenario," American Economic Review, vol 106(9), pages 2494-2527.

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Related works:
Journal Article: Long-Run Risk Is the Worst-Case Scenario (2016)
Working Paper: Long-Run Risk is the Worst-Case Scenario (2015)
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