TY - JOUR AU - Croce, Mariano M AU - Lettau, Martin AU - Ludvigson, Sydney C TI - Investor Information, Long-Run Risk, and the Term Structure of Equity JF - National Bureau of Economic Research Working Paper Series VL - No. 12912 PY - 2007 Y2 - February 2007 DO - 10.3386/w12912 UR - http://www.nber.org/papers/w12912 L1 - http://www.nber.org/papers/w12912.pdf N1 - Author contact info: Mariano Max Croce Bocconi University Milan ITALY E-Mail: mmc287@gmail.com Martin Lettau Haas School of Business University of California, Berkeley 545 Student Services Bldg. #1900 Berkeley, CA 94720-1900 Tel: 510/642-6349 Fax: 510/643-1412 E-Mail: lettau@haas.berkeley.edu Sydney C. Ludvigson Department of Economics New York University 19 W. 4th Street, 6th Floor New York, NY 10002 Tel: 212/998-8927 Fax: 212/995-4186 E-Mail: sydney.ludvigson@nyu.edu AB - We study the role of information in asset pricing models with long-run cash flow risk. When investors can distinguish short- from long-run consumption risks (full information), the model generates a sizable equity risk premium only if the equity term structure slopes up, contrary to the data. In general, the short- and long-run components are unidentified. We propose a sparsity-based bounded rationality model of long-run risk that is both parsimonious and fully identified from historical data. In contrast to full information, the model generates a sizable market risk premium simultaneously with a downward sloping equity term structure, as in the data. ER -