The Time Variation in Risk Appetite and Uncertainty

By Geert Bekaert, Eric C. Engstrom, Nancy R. Xu. Management Sciences, 2019

369 citations recorded by the source corpus.

We formulate a dynamic no-arbitrage asset pricing model for equities and corporate bonds, featuring time variation in both risk aversion and economic uncertainty. The joint dynamics among cash flows, macroeconomic fundamentals, and risk aversion accommodate both heteroskedasticity and non-Gaussianity. The model delivers measures of risk aversion and uncertainty at the daily frequency. We verify that equity variance risk premiums are very informative about risk aversion, whereas credit spreads and corporate bond volatility are highly correlated with economic uncertainty. Our model-implied risk premiums outperform standard instruments for predicting asset excess returns. Risk aversion is substantially correlated with consumer confidence measures and in early 2020 reacted more strongly to new COVID cases than did an uncertainty proxy. This paper was accepted by Haoxiang Zhu, finance.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/97b5690fe8c21d0c1ab5cb0e2a76b6af06270fd9

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Citations in the corpus

U.S. Monetary Policy and the Global Financial Cycle (2020, background): “The construction of our proxy for aggregate risk aversion is modelled along the lines of e.g. Bekaert et al. (2013), that estimate variance risk premia as the difference between a measure of the implied variance (the squared VIX) and an estimated physical expected variance, which is primarily a…”