Critical Finance Review > Vol 10 > Issue 3

High Aversion to Stochastic Time Preference Shocks and Counterfactual Long-Run Risk in the Albuquerque et al., Valuation Risk Model

Samuel Kruger, McCombs School of Business, University of Texas at Austin, USA, Sam.Kruger@mccombs.utexas.edu
 
Suggested Citation
Samuel Kruger (2021), "High Aversion to Stochastic Time Preference Shocks and Counterfactual Long-Run Risk in the Albuquerque et al., Valuation Risk Model", Critical Finance Review: Vol. 10: No. 3, pp 383-408. http://dx.doi.org/10.1561/104.00000093

Publication Date: 02 Aug 2021
© 2021 Samuel Kruger
 
Subjects
 
Keywords
D81G11G12
Valuation riskEquity premiumStochastic time preferences
 

Share

Download article
In this article:
1. Theory 
2. Preference Assessment 
3. Empirical Assessment 
4. Conclusion 
References 

Abstract

Does valuation risk induced by stochastic time preferences explain the equity premium puzzle as proposed by Albuquerque et al. (2016)? This explanation of the equity premium has several challenges. First, the valuation risk model implies extreme preference for early resolution of uncertainty and extreme aversion to valuation risk (which becomes infinite as elasticity of intertemporal substitution approaches 1). Second, the model has a significant long-run risk component that counterfactually implies that consumption and dividend growth are highly persistent and predictable. Finally, I find no evidence that equity prices predict future risk-free rates as predicted by the baseline valuation risk model.

DOI:10.1561/104.00000093

Replication Data | 104.00000093_supp.zip (ZIP).

This file contains the data that is required to replicate the data on your own system.

DOI: 10.1561/104.00000093_supp

Online Appendix | 104.00000093_app.pdf

This is the article’s accompanying appendix.

DOI: 10.1561/104.00000093_app