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Recursive preferences, long-run risks, and stock valuation

Author

Listed:
  • Claude Bergeron

    (School of Business Administration, Teluq University)

Abstract

In this note, we develop a stock valuation model with recursive preferences and long-run risks. The model is based on the Epstein and Zin (1989, 1991) and Weil (1989) recursive utility framework. Our main result indicates that the intrinsic value of a stock is negatively related to (i) the long-run covariance between dividends and aggregate consumption, and (ii) the long-run covariance between dividends and market returns. This theoretical finding suggests that the sensitivity of dividends to market returns and aggregate consumption affects the long-run risk of a firm and its equity value.

Suggested Citation

  • Claude Bergeron, 2019. "Recursive preferences, long-run risks, and stock valuation," Economics Bulletin, AccessEcon, vol. 39(2), pages 996-1004.
    • Handle: RePEc:ebl:ecbull:eb-19-00289
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    References listed on IDEAS

    as
    1. Bansal, Ravi & Kiku, Dana & Yaron, Amir, 2016. "Risks for the long run: Estimation with time aggregation," Journal of Monetary Economics, Elsevier, vol. 82(C), pages 52-69.
    2. Da, Zhi & Warachka, Mitchell Craig, 2009. "Cashflow risk, systematic earnings revisions, and the cross-section of stock returns," Journal of Financial Economics, Elsevier, vol. 94(3), pages 448-468, December.
    3. repec:hal:spmain:info:hdl:2441/8686 is not listed on IDEAS
    4. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
    5. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    6. Bansal, Ravi & Kiku, Dana, 2011. "Cointegration and Long-Run Asset Allocation," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(1), pages 161-173.
    7. Ferson, Wayne & Nallareddy, Suresh & Xie, Biqin, 2013. "The “out-of-sample” performance of long run risk models," Journal of Financial Economics, Elsevier, vol. 107(3), pages 537-556.
    8. Lars Peter Hansen & John C. Heaton & Nan Li, 2008. "Consumption Strikes Back? Measuring Long-Run Risk," Journal of Political Economy, University of Chicago Press, vol. 116(2), pages 260-302, April.
    9. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-286, April.
    10. Bergeron, Claude, 2013. "Dividend sensitivity to economic factors, stock valuation, and long-run risk," Finance Research Letters, Elsevier, vol. 10(4), pages 184-195.
    11. Claude Bergeron, 2013. "Dividend growth, stock valuation, and long-run risk," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 37(4), pages 547-559, October.
    12. Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
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    Cited by:

    1. Claude Bergeron & Tov Assogbavi & Jean-pierre Gueyie, 2020. "Conditional capital asset pricing model, long-run risk, and stock valuation," Economics Bulletin, AccessEcon, vol. 40(1), pages 77-86.

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    More about this item

    Keywords

    Recursive preferences; Asset pricing; Long-run risk; Stock valuation;
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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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