The Time Variation in Risk Appetite and Uncertainty

Abstract

We formulate a dynamic no-arbitrage asset pricing model for equities and corporate bonds, featuring time variation in both risk aversion and economic uncertainty. The joint dynamics among cash flows, macroeconomic fundamentals, and risk aversion accommodate both heteroskedasticity and non-Gaussianity. The model delivers measures of risk aversion and uncertainty at the daily frequency. We verify that equity variance risk premiums are very informative about risk aversion, whereas credit spreads and corporate bond volatility are highly correlated with economic uncertainty. Our model-implied risk premiums outperform standard instruments for predicting asset excess returns. Risk aversion is substantially correlated with consumer confidence measures and in early 2020 reacted more strongly to new COVID cases than did an uncertainty proxy. This paper was accepted by Haoxiang Zhu, finance.

The lead of oil price rises on US equity market beliefs and preferences

“…In the low‐volatility period leading up to GFC, strong gains in the equity market coincided with increasingly higher levels of risk aversion (as the left tail of the PK became more negatively sloped). Findings are inconsistent with risk aversion increasing when volatility rises (Bekaert et al, 2021; Bollerslev et al, 2011). If low volatility is associated with a strong economy, they are also at odds with countercyclical risk aversion (Campbell & Cochrane, 1999; Rosenberg & Engle, 2002).…”

ABD Ticaret Politikası Belirsizliğinin Türk Finansal Piyasalarına ve Banka Kredilerine Etkileri

“…Values in the parentheses show the probabilities. R.A. refers to the time-varying risk aversion index constructed by Bekaert et al (2019). Values in the parentheses show the probabilities.…”

Does model complexity add value to asset allocation? Evidence from machine learning forecasting models

“…In the previous section, we used values for the parameter of risk aversion that remain fixed across the portfolio formation period. Here, we employ a new measure of time-varying risk aversion, named RAbex, proposed by Bekaert et al (2021), which is derived from observable financial variables, such as earnings yield, corporate return spread (Baa-Aaa), term spread (10 yr-3mth), equity return realized variance, corporate bond return realized variance, and equity risk-neutral variance. 15 The results for the average return, Sharpe ratio, and turnover are reported in Table S8.…”