The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment
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.
We are grateful to Ravi Bansal, Dana Kiku, and Amir Yaron for their comments on the first version of this paper. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Beeler, Jason & Campbell, John Y., 2012. "The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment," Critical Finance Review, now publishers, vol. 1(1), pages 141-182, January. citation courtesy of