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Journal of Finance Vol. 59 No. 4 2004

Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles

Ravi Bansal1; Amir Yaron2,3,4

1 Duke University · 2 National Bureau of Economic Research · 3 Saint John's University · 4 University of Pennsylvania

open access

Abstract

We model consumption and dividend growth rates as containing (1) a small long‐run predictable component, and (2) fluctuating economic uncertainty (consumption volatility). These dynamics, for which we provide empirical support, in conjunction with Epstein and Zin's (1989) preferences, can explain key asset markets phenomena. In our economy, financial markets dislike economic uncertainty and better long‐run growth prospects raise equity prices. The model can justify the equity premium, the risk‐free rate, and the volatility of the market return, risk‐free rate, and the price–dividend ratio. As in the data, dividend yields predict returns and the volatility of returns is time‐varying.

DOI
10.1111/j.1540-6261.2004.00670.x
Volume
59
Issue
4
Pages
1481-1509
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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