Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467
Institutional Affiliation: Boston College
NBER Working Papers and Publications
|March 2019||The Time Variation in Risk Appetite and Uncertainty|
with Geert Bekaert, Eric C. Engstrom: w25673
We develop measures of time-varying risk aversion and economic uncertainty that are calculated from financial variables at high frequencies. We formulate a dynamic no-arbitrage asset pricing model for equities and corporate bonds. The joint dynamics among asset-specific cash flows, macroeconomic fundamentals and risk aversion feature heteroskedasticity and non-Gaussianity. Variance risk premiums on equity are very informative about risk aversion, whereas credit spreads and corporate bond volatility are highly correlated with economic uncertainty. Model-implied risk premiums outperform standard instruments for predicting excess returns on equity and corporate bonds. A financial proxy to our economic uncertainty predicts output growth significantly negatively.