Valuation Risk Revalued

Abstract

This paper shows the recent success of valuation risk (time-preference shocks in Epstein-Zin utility) in resolving asset pricing puzzles rests sensitively on an undesirable asymptote that occurs because the preference specification fails to satisfy a key restriction on the weights in the Epstein-Zin time-aggregator. When we revise the preferences to satisfy the restriction in a simple asset pricing model, the puzzles resurface. However, when estimating a sequence of Bansal-Yaron long-run risk models, we find valuation risk under the revised specification consistently improves the ability of the models to match asset price and cash-flow dynamics.

Valuation risk revalued

“…Section 8 concludes. The Online Appendix mentioned throughout the paper may be found in the Replication File in the Online Supplementary Material (de Groot, Richter, and Throckmorton (2022)).…”