The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment

By J. Beeler, John Y. Campbell. Critical Finance Review, 2012

448 citations recorded by the source corpus.

The long-run risks model of asset prices explains stock price variation as a response to persistent fluctuations in the mean and volatility of aggregate consumption growth, by a representative agent with a high elasticity of intertemporal substitution. This paper documents several empirical difficulties for the model as calibrated by Bansal and Yaron (BY, 2004) and Bansal, Kiku, and Yaron (BKY, 2007a). BY's calibration counterfactually implies that long-run consumption and dividend growth should be highly persistent and predictable from stock prices. BKY's calibration does better in this respect by greatly increasing the persistence of volatility fluctuations and their impact on stock prices. This calibration fits the predictive power of stock prices for future consumption volatility, but implies much greater predictive power of stock prices for future stock return volatility than is found in the data. Neither calibration can explain why movements in real interest rates do not generate strong predictable movements in consumption growth. Finally, the long-run risks model implies extremely low yields and negative term premia on inflation-indexed bonds.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/8f58a86073d23a6c8ea553fde24e493d3b03f357

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Citations in the corpus

Dividend Dynamics and the Term Structure of Dividend Strips (2015, unknown): “…results reported here (using an alternative data set of aggregate dividend data of publicly and privately traded firms) confirm the analysis of Beeler and Campbell (2012), who show, using annual aggregate dividend data for publicly traded firms for the 1930 to 2008 period, that dividend…”
Growth-Rate and Uncertainty Shocks in Consumption: Cross-Country Evidence (2012, unknown): “A recent critique of the long-run risks model by Beeler and Campbell (2012) is that it generates too much predictability of consumption growth.”
The Term Structure of Returns: Facts and Theory (2015, methodology): “As a second test, we compute the volatility of equity yields in the data and we provide a comparison to the Campbell and Cochrane (1999) model for illustration. The volatility of equity yields is much higher in the data than in the model. As we measure volatilities more precisely than average return”
Disaster Risk and its Implications for Asset Pricing (2015, unknown): “21One concern about high values of the EIS is that generate a counterfactual relation between the riskfree rate and consumption growth in Hall (1988) regressions (see the discussion in Beeler and Campbell (2012)).”
What Ties Return Volatilities to Price Valuations and Fundamentals? (2013, unknown): “C.3Þ imply a negative relation between valuation ratios and volatility ðsee also Beeler and Campbell 2012Þ.”
Asset Pricing with Countercyclical Household Consumption Risk (2017, unknown): “The proxy for the real annual risk free rate is obtained as in Beeler and Campbell (2012). Specifically, the quarterly nominal yield on 3-month Treasury Bills is deflated using the realized growth in the Consumer Price Index to obtain the ex post real 3-month T-Bill rate.”
Investor Attention and Stock Market Volatility (2015, background): “Plugging the exponential form (10) in Equation (9) and performing a first order linearization of the PDE around x = ( f̄ 0 γss ) 17”
Asset Pricing in the Frequency Domain: Theory and Empirics (2016, methodology): “To give a closer comparison to the time-domain methods used in the previous literature to study the role of dynamics in models (e.g., Bansal, Kiku, and Yaron, 2010, 2012; Beeler and Campbell, 2012), we now consider a small perturbation of Bansal and Yaron’s (2004) long-run risk”
How Much Would You Pay to Resolve Long-Run Risk? (2014, unknown): “The preceding, and hence also equations (10) and (11), rely only on lognormality and on the fact that μda satisfies (12).”
Uncertainty Shocks and Balance Sheet Recessions (2017, background): “As long as the aggregate shock depresses asset values and experts are leveraged, their balance sheets will (42)Campbell and Beeler (2009) use an EIS of 1.”