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  • August 2020
  • Article
  • Journal of Political Economy

Macroeconomic Drivers of Bond and Equity Risks

By: John Y. Campbell, Carolin E. Pflueger and Luis M. Viceira
  • Format:Print
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Abstract

Our new model of consumption-based habit generates time-varying risk premia on bonds and stocks from loglinear, homoskedastic macroeconomic dynamics. Consumers' first-order condition for the real risk-free bond generates an exactly loglinear consumption Euler equation, commonly assumed in New Keynesian models. We estimate that the correlation between inflation and the output gap switched from negative to positive in 2001. Higher inflation lowers real bond returns, and higher output raises stock returns, explaining why the bond-stock return correlation changed from positive to negative. In the model, risk premia amplify this change in bond-stock return comovement and are crucial for a quantitative explanation.

Keywords

Consumption-based Habit Formation; Consumption Euler Equation; Time-varying Risk Premia; Inflation Dynamics; Bond-stock Correlation; Risk and Uncertainty; Bonds; Macroeconomics

Citation

Campbell, John Y., Carolin E. Pflueger, and Luis M. Viceira. "Macroeconomic Drivers of Bond and Equity Risks." Journal of Political Economy 128, no. 8 (August 2020): 3148–3185.

Supplemental Information

Appendix
Appendix
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About The Author

Luis M. Viceira

Finance
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More from the Authors
  • Modern Endowment Management: Paula Volent and the Bowdoin Endowment By: Luis M. Viceira
  • Retail Investors’ Contrarian Behavior Around News and the Momentum Effect By: Cheng (Patrick) Luo, Enrichetta Ravina, Marco Sammon and Luis M. Viceira
  • Valuing Yahoo! in 2013 (Abridged) By: Luis M. Viceira
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