Financial Markets and the Real Economy
I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of "bad times," rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets' tendency to pay off poorly in "bad times." I survey the literature, covering the time-series and cross-sectional facts, the equity premium, consumption-based models, general equilibrium models, and labor income/idiosyncratic risk approaches.
Published: Cochrane, John (ed.) Financial Markets and the Real Economy Volume 18 of the International Library of Critical Writings in Financial Economics. London: Edward Elgar, March 2006.
This paper was revised on September 26, 2006