Asset Pricing Puzzle: The Long-Run Risks Model's Approach

The magnitude of risk compensation in equity markets is an enduring puzzle in the field of the Economics of Finance. Bansal and Yaron (2004) and Bansal, Kiku and Yaron (2007a,b) have recently addressed the topic by picking out the long run growth prospects and the level of economic uncertainty in the economy as the key drivers of risks. Although their “Long-Run Risks” model successfully defines a solid theoretical framework within the ongoing debate, on the empirical side this work reveals the existence of a non-negligible model specification problem that should be addressed by further research.