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Stochastic Volatility, Long Run Risks, And Aggregate Stock Market Fluctuations

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Executive Summary

What are the main drivers of fluctuations in the aggregate US stock market? In this paper, the authors attempt to resolve the long-lasting debate surrounding this question by designing and solving a consumption-based asset pricing model which incorporates stochastic volatility, long-run risks in consumption and dividends, and Epstein-Zin preferences. These results indicate that, over short and medium horizons, fluctuations in the level of the aggregate US stock market are mainly driven by changes in expected excess returns.

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