In asset pricing, a macroeconomic risk is an event that can influence most financial assets. We measure it through country-level variables like the gross domestic product, aggregate consumption, interest rates, inflation, and exchange rate. Many studies have explored the role of these macro-variables in explaining a firm or a country’s financial decisions and on the pricing of stocks, corporate and sovereign bonds. They point out the critical role of macroeconomic risk in explaining the dynamics of asset prices, as opposed to the canonical CAPM type of risk. Among these works, consumption-based models are one of the most popular.
There are (at least) two sources of macroeconomic risk into consumption dynamics: short-run risk originating from temporary disturbance or Brownian shocks and long-run risk characterised by low-frequency changes in consumption growth rate and volatility. A rational investor who cares not only about shocks to her consumption but also the arrival and length of bad economic periods should incorporate these two sources of risk into financial assets valuation. Current research examines either the first or second source, making it impossible to understand their relative contribution or the role of the long-run risk.