Macroeconomic Risks and Asset Pricing: Evidence from a Dynamic Stochastic General Equilibrium Model
Erica X. N. Li, Haitao Li, Shujing Wang, Cindy Yu
Management Science · 2019 · Volume 65 · Issue 8
Abstract
We study the relation between macroeconomic fundamentals and asset pricing through the lens of a dynamic stochastic general equilibrium (DSGE) model. We provide full-information Bayesian estimation of the DSGE model using macroeconomic variables and extract the time series of four latent fundamental shocks of the model: neutral technology shock, investment-specific technological shock, monetary policy shock, and risk shock. Asset pricing tests show that our model-implied four-factor model can explain a number of prominent cross-sectional return spreads: size, book-to-market, investment, earnings, and long-term reversal. The investment-specific technological shock and risk shock play the most important role in explaining those return spreads. This paper was accepted by Neng Wang, finance.
Keywords
DSGE model, Bayesian MCMC estimation, stock returns, neutral technology shock, investment-specific technology shock, monetary policy shock, risk shock
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