The Real Risk-Free Rate and the Price of Equity : What Role does Macroeconomic Uncertainty Play?

Between 37% and 75% of quarterly variations in the U.S. aggregate logarithmic price-dividend ratio are related to economic information that is embedded in the real risk-free rate. Only one hidden factor is required to explain more than 80\% of these common variations. Surprisingly, standard measures of macroeconomic risks seem not to contain information about this unobserved common factor. As surprising, a standard measure of macroeconomic uncertainty explains more than 50\% of its variations. The revealed empirical pattern between macroeconomic uncertainty, the real risk-free rate and the price of equity is at odds with existing theoretical models. We analyze theoretically and empirically the reasons for this puzzle and derive suggestions to overcome these