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Valuation Risk Revalued

No. 1808 (Revised May 2019)

Oliver de Groot, Alexander W. Richter and Nathaniel A. Throckmorton

Abstract: This paper shows the recent success of valuation risk (time-preference shocks in Epstein-Zin utility) in resolving asset pricing puzzles rests sensitively on an undesirable asymptote that occurs because the preference specification fails to satisfy a key restriction on the weights in the Epstein-Zin time-aggregator. When we revise the preferences to satisfy the restriction in a simple asset pricing model, the puzzles resurface. However, when estimating a sequence of Bansal-Yaron long-run risk 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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