Macroeconomic Risk and Idiosyncratic Risk-taking


*Corresponding author for this work

Research output: Journal PublicationsJournal Article (refereed)peer-review

18 Citations (Scopus)


We develop and estimate a dynamic model of risk-shifting over the business cycle. First, equity holders with Epstein-Zin preferences increase their taking of idiosyncratic risk substantially more than the standard model in repeated games, because they perceive the arrival probability of bad states to be higher than the actual probability and prefer an early resolution of macroeconomic uncertainty. Second, sudden switches to bad states and large shocks in the bad states induce the countercyclical and “synchronized” idiosyncratic risk. Third, combined with the high market risk premium in the bad states, clustered risk-taking generates a countercyclical idiosyncratic volatility discount on equity returns.

Original languageEnglish
Pages (from-to)1148-1187
Number of pages40
JournalReview of Financial Studies
Issue number3
Early online date8 Jun 2018
Publication statusPublished - Mar 2019
Externally publishedYes

Bibliographical note

We thank the editor, Stijn Van Nieuwerburgh, and two anonymous referees for constructive suggestions, Erik Loualiche, Jun Li and participants of 2018 AFA meetings for helpful comments. We also thank Yi Hu for excellent research assistance. Zhiyao Chen acknowledges financial support from the General Research Fund by the Hong Kong Research Grants Council (project 14519816). All errors remain our own. Supplementary data can be found on The Review of Financial Studies Web site.

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