Asset Prices and Capital Share Risks: Theory and Evidence

TL;DR

This paper develops a recursive utility asset pricing model incorporating capital share growth risks, explaining U.S. stock returns and highlighting the role of capital share risks in stock return volatility.

Contribution

It introduces a novel recursive preference framework with heterogeneous agents to model capital share risks and their impact on asset prices.

Findings

Capital share growth risk explains U.S. stock returns.

Capital risks significantly influence stock return volatility.

Empirical evidence supports capital share risks as a source of return variation.

Abstract

An asset pricing model using long-run capital share growth risk has recently been found to successfully explain U.S. stock returns. Our paper adopts a recursive preference utility framework to derive an heterogeneous asset pricing model with capital share risks.While modeling capital share risks, we account for the elevated consumption volatility of high income stockholders. Capital risks have strong volatility effects in our recursive asset pricing model. Empirical evidence is presented in which capital share growth is also a source of risk for stock return volatility. We uncover contrasting unconditional and conditional asset pricing evidence for capital share risks.