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Financial Market Risk Perceptions and the Macroeconomy

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  • Carolin Pflueger
  • Emil Siriwardane
  • Adi Sunderam

Abstract

We propose a novel measure of risk perceptions: the price of volatile stocks (PVSₜ), defined as the book-to-market ratio of low-volatility stocks minus the book-to-market ratio of high-volatility stocks. PVSₜ is high when perceived risk directly measured from surveys and option prices is low. When perceived risk is high according to our measure, safe asset prices are high, risky asset prices are low, the cost of capital for risky firms is high, and real investment is forecast to decline. Perceived risk as measured by PVSₜ falls after positive macroeconomic news. These declines are predictably followed by upward revisions in investor risk perceptions. Our results suggest that risk perceptions embedded in stock prices are an important driver of the business cycle and are not fully rational.

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  • Carolin Pflueger & Emil Siriwardane & Adi Sunderam, 2019. "Financial Market Risk Perceptions and the Macroeconomy," NBER Working Papers 26290, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:26290
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    JEL classification:

    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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