Asset Pricing in the Frequency Domain: Theory and Empirics

Abstract

We quantify investors’ preferences over the dynamics of shocks by deriving frequency-specific risk prices that capture the price of risk of consumption fluctuations at each frequency. The frequency-specific risk prices are derived analytically for leading models. The decomposition helps measure the importance of economic fluctuations at different frequencies. We precisely quantify the meaning of "long-run" in the context of Epstein-Zin preferences – centuries – and measure the exact relevance of business-cycle fluctuations. Finally, we estimate frequency-specific risk prices and show that cycles longer than the business cycle – long-run risks – are significantly priced in the equity market. Received January 13, 2015; accepted February 23, 2016 by Editor Leonid Kogan.