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The Time Variation in Risk Appetite and Uncertainty

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  • Geert Bekaert
  • Eric C. Engstrom
  • Nancy R. Xu

Abstract

We develop measures of time-varying risk aversion and economic uncertainty that are calculated from financial variables at high frequencies. We formulate a dynamic no-arbitrage asset pricing model for equities and corporate bonds. The joint dynamics among asset-specific cash flows, macroeconomic fundamentals and risk aversion feature heteroskedasticity and non-Gaussianity. Variance risk premiums on equity are very informative about risk aversion, whereas credit spreads and corporate bond volatility are highly correlated with economic uncertainty. Model-implied risk premiums outperform standard instruments for predicting excess returns on equity and corporate bonds. A financial proxy to our economic uncertainty predicts output growth significantly negatively.

Suggested Citation

  • Geert Bekaert & Eric C. Engstrom & Nancy R. Xu, 2019. "The Time Variation in Risk Appetite and Uncertainty," NBER Working Papers 25673, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:25673
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    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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