Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/159573 
Year of Publication: 
2011
Series/Report no.: 
Quaderni - Working Paper DSE No. 732
Publisher: 
Alma Mater Studiorum - Università di Bologna, Dipartimento di Scienze Economiche (DSE), Bologna
Abstract: 
This note sketches the issues that arise while interpreting the relation between macroeconomic volatility and financial risk premia from the perspective of the standard consumption-based asset pricing model. The relation arises from the fact that all assets are priced by the same 'pricing kernel', given by the inter-temporal marginal rate of substitution in consumption of the representative investor. Since the pricing kernel is a function of aggregate consumption, financial risk premia are positively related to consumption growth volatility. Therefore, from the perspective of this workhorse often employed in the academic debate, the persistent reduction in macroeconomic volatility can be considered a cause for the low average risk premia prevailing during the so-called Great Moderation, namely the period preceding the recent turmoil in financial markets. We challenge this view by shedding light on the issues that generate an inconsistent interpretation of the model outcomes. In particular, since the consumption-based model is geared towards asset prices consistent with macroeconomic fundamentals, we argue that it is not suited for interpreting current developments where underestimation of risk may have subsidized asset prices. In particular, according to the evidence for the Great Moderation, the model view suffers from observational equivalence.
JEL: 
E43
G12
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by-nc Logo
Document Type: 
Working Paper

Files in This Item:
File
Size
276.87 kB





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.