Volatility, the Macroeconomy and Asset Prices
We show that volatility movements have first-order implications for consumption dynamics and asset prices. Volatility news affects the stochastic discount factor and carries a separate risk premium. In the data, volatility risks are persistent and are strongly correlated with discount-rate news. This evidence has important implications for the return on aggregate wealth and the cross-sectional differences in risk premia. Estimation of our volatility risks based model yields an economically plausible positive correlation between the return to human capital and equity, while this correlation is implausibly negative when volatility risk is ignored. Our model setup implies a dynamics capital asset pricing model (DCAPM) which underscores the importance of volatility risk in addition to cash-flow and discount-rate risks. We show that our DCAPM accounts for the level and dispersion of risk premia across book-to-market and size sorted portfolios, and that equity portfolios carry positive volatility-risk premia.
We thank seminar participants at NBER Spring 2012 Asset-Pricing Meeting, AFA 2012, SED 2011, Arizona State University, Duke University, London School of Economics, NYU-Five Star conference, The Wharton School, Vanderbilt University, University of British Columbia, University of New South Wales, University of Sydney, and University of Technology Sydney for their comments. Shaliastovich and Yaron thank the Rodney White Center for financial support The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
“Volatility, the Macroeconomy and Asset Prices” (Dana Kiku, Ivan Shaliastovich, and Amir Yaron) Journal of Finance, Volume 69, Issue 6, December 2014, Pages 2471–2511