Economic Growth, Business Cycles, and Expected Stock Returns

This article presents a dynamic general equilibrium model which jointly accounts for main asset pricing phenomena of the time series and the cross sec-tion. Learning about changes in long-run output growth leads to time-variation in risk premia. Covariance with GDP growth through business cycles deter-mines a countercyclical equity premium. Countercyclical value (size) spreads and value (size) premia arise in compensation for systematic di¤erences in the time-varying exposure of \u85rm fundamentals to business cycle uctuations. The Fama and French (1993) factors HML and SMB are shown to capture \u85rmsrel-ative exposure to recessionary periods of the economy. The model extends the consumption-based CAPM (CCAPM) to an output-based CAPM (YCAPM). Key words: asset pricing, general equilibrium, learning, macroeconomic risk, time-varying risk premi