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Discussion Paper Details

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Title: Valuation Risk Revalued

Author(s): Oliver de Groot, Alexander Richter and Nathaniel Throckmorton

Publication Date: April 2020

Keyword(s): Asset Pricing, Equity premium puzzle, recursive utility and Risk-Free Rate Puzzle

Programme Area(s): Financial Economics

Abstract: This paper shows the success of valuation risk-time-preference shocks in Epstein-Zin utility-in resolving asset pricing puzzles rests sensitively on the way it is introduced. The specification used in the literature violates several desirable properties of recursive preferences because the weights in the Epstein-Zin time-aggregator do not sum to one. When we revise the specification in a simple asset pricing model the puzzles resurface. However, when estimating a sequence of increasingly rich models, we find valuation risk under the revised specification consistently improves the ability of the models to match asset price and cash-flow dynamics.

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Bibliographic Reference

de Groot, O, Richter, A and Throckmorton, N. 2020. 'Valuation Risk Revalued'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=14588