Finance Papers

Document Type

Journal Article

Date of this Version

2011

Publication Source

Journal of Financial Economics

Volume

101

Issue

1

Start Page

90

Last Page

113

DOI

10.1016/j.jfineco.2011.02.014

Abstract

This paper proposes a dynamic risk-based model capable of jointly explaining the term structure of interest rates, returns on the aggregate market, and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks convey information about how the representative investor values cash flows of different maturities. We model how the representative investor perceives risks of these cash flows by specifying a parsimonious stochastic discount factor for the economy. Shocks to dividend growth, the real interest rate, and expected inflation are priced, but shocks to the price of risk are not. Given reasonable assumptions for dividends and inflation, we show that the model can simultaneously account for the behavior of aggregate stock returns, an upward-sloping yield curve, the failure of the expectations hypothesis, and the poor performance of the capital asset pricing model.

Copyright/Permission Statement

© 2011. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/.

Share

COinS
 

Date Posted: 27 November 2017

This document has been peer reviewed.