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Good and Bad Uncertainty: Macroeconomic and Financial Market Implications
, 2013
"... Does macroeconomic uncertainty increase or decrease aggregate growth and asset prices? To address this question, we decompose aggregate uncertainty into ‘good ’ and ‘bad ’ volatility components, associated with positive and negative innovations to macroeconomic growth. We document that in line with ..."
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Cited by 2 (0 self)
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Does macroeconomic uncertainty increase or decrease aggregate growth and asset prices? To address this question, we decompose aggregate uncertainty into ‘good ’ and ‘bad ’ volatility components, associated with positive and negative innovations to macroeconomic growth. We document that in line with our theoretical framework, these two uncertainties have opposite impact on aggregate growth and asset prices. Good uncertainty predicts an increase in future economic activity, such as consumption, output, and investment, and is positively related to valuation ratios, while bad uncertainty forecasts a decline in economic growth and depresses asset prices. Further, the market price of risk and equity beta of good uncertainty are positive, while negative for bad uncertainty. Hence, both uncertainty risks contribute positively to risk premia, and help explain the crosssection of expected returns beyond cash flow risk.
Disaster Risk and Preference Shifts in a New Keynesian Model
, 2015
"... A timevarying probability of ‘disaster ’ is sufficient to generate a recession and an increase in risk premia in the literature. However, this result critically relies on the value of the elasticity of intertemporal substitution (EIS). Indeed, when the EIS is smaller than unity, the agents choose t ..."
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A timevarying probability of ‘disaster ’ is sufficient to generate a recession and an increase in risk premia in the literature. However, this result critically relies on the value of the elasticity of intertemporal substitution (EIS). Indeed, when the EIS is smaller than unity, the agents choose to save and invest more. In a real business cycle model, an increase in disaster risk thus creates a boom. The New Keynesian structure allows to conciliate the recessionary effects of disaster risk with a plausible value of the EIS through the sluggishness in price adjustments. The model then generates recession and deflation, as well as a decrease in consumption, investment and wages, in line with the preference shock literature, while it preserves the countercyclicality of risk premia.
Federal Reserve Bank at Kansas City
, 2015
"... Under linear approximations for asset prices and the assumption of independence between expected consumption growth and timevarying volatility, longrun risks models imply constant market prices of risks and often generate counterfactual results about asset return and cash flow predictability. We ..."
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Under linear approximations for asset prices and the assumption of independence between expected consumption growth and timevarying volatility, longrun risks models imply constant market prices of risks and often generate counterfactual results about asset return and cash flow predictability. We develop and estimate a nonlinear equilibrium asset pricing model with recursive preferences and a flexible econometric specification of cash flow processes. While in many longrun risks models timevarying volatility influences only risk premium but not expected cash flows, in our model a common set of risk factors drive both expected cash flow and risk premium dynamics. This feature helps the model to overcome two main criticisms against longrun risk models following Bansal and Yaron (2004): the overpredictability of cash flows by asset prices and the tight relation between timevarying risk premia and growth volatility. Our model extends the approach in Le and Singleton (2010) to a setting with multiple cash flows. We estimate the model using the longrun historical data in the U.S. and find that the model with generalized market prices of risks produces cash flow and return predictability that are more consistent with the data. Key Words: Longrun consumption risks; Timevarying risk premium; Recursive preferences