Financial markets and the real economy

NBER WORKING PAPER SERIES

FINANCIAL MARKETS AND THE REAL ECONOMY
John H. Cochrane
Working Paper 11193 http://www.nber.org/papers/w11193 NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
March 2005

This review will introduce a volume by the same title in the Edward Elgar series “The International Library of Critical Writings in Financial Economics” edited by Richard Roll. I encourage comments. Please write promptly so I can include your comments in the final version. I gratefully acknowledge research support from the NSF in a grant administered by the NBER and from the CRSP. I thank Monika Piazzesi and Motohiro
Yogo for comments. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
© 2005 by John H. Cochrane. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

Financial Markets and the Real Economy
John H. Cochrane
NBER Working Paper No. 11193
March 2005, Revised September 2006
JEL No. G1, E3
ABSTRACT
I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of "bad times," rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets ' tendency to pay off poorly in "bad times."
I survey the literature, covering the time-series and cross-sectional facts, the equity premium, consumption-based models, general equilibrium models, and labor income/idiosyncratic risk approaches. John H. Cochrane
Graduate School of Business
University of Chicago
5807 S. Woodlawn
Chicago, IL 60637 and NBER [e-mail] 1

Introduction

Risk premia
Some assets offer higher average returns than other assets, or, equivalently, they attract lower prices.

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