Risk, Uncertainty and Asset Prices

55 Pages Posted: 25 May 2006 Last revised: 26 Dec 2022

See all articles by Geert Bekaert

Geert Bekaert

Columbia University - Columbia Business School, Finance

Eric Engstrom

Board of Governors of the Federal Reserve System

Yuhang Xing

Rice University

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Date Written: May 2006

Abstract

We identify the relative importance of changes in the conditional variance of fundamentals (which we call "uncertainty") and changes in risk aversion ("risk" for short) in the determination of the term structure, equity prices and risk premiums. Theoretically, we introduce persistent time-varying uncertainty about the fundamentals in an external habit model. The model matches the dynamics of dividend and consumption growth, including their volatility dynamics and many salient asset market phenomena. While the variation in dividend yields and the equity risk premium is primarily driven by risk, uncertainty plays a large role in the term structure and is the driver of counter-cyclical volatility of asset returns.

Suggested Citation

Bekaert, Geert and Engstrom, Eric C. and Xing, Yuhang, Risk, Uncertainty and Asset Prices (May 2006). NBER Working Paper No. w12248, Available at SSRN: https://ssrn.com/abstract=903886

Geert Bekaert (Contact Author)

Columbia University - Columbia Business School, Finance ( email )

NY
United States

Eric C. Engstrom

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
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202-452-3044 (Phone)

Yuhang Xing

Rice University ( email )

6100 South Main Street
Houston, TX 7705-1892
United States