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Short-run risk, business cycle, and the value premium. (English) Zbl 1475.91329

Summary: We jointly explain the equity and value premium variations in a model with both short-run (SRR) and long-run (LRR) consumption risk. In our empirical analysis, we find that SRR varies with the business cycle, and it has a substantial predictive power for market excess returns and the value premium – both in-sample and out-of-sample. The LRR component also differs significantly from zero, and value stocks have a larger exposure to both LRR and SRR than growth stocks. To explain these patterns in asset returns, we propose an extended LRR model. The model can be solved using log-linear approximations with economically small errors.

MSC:

91G10 Portfolio theory

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DEoptim
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