ASSET PRICES IN DYNAMIC PRODUCTION ECONOMIES WITH TIME-VARYING RISK

We examine the effect of changes in output uncertainty on the price of aggregate capital and on the prices of levered claims on capital. The relation between the volatility of the marginal product of capital and the price of capital depends on the level of capital adjustment costs and the elasticity of intertemporal substitution. For available estimates of this elasticity, the value of capital and risk are directly related while the value of levered equity claims on capital may be decreasing in risk. We use these results to analyze the argument that increased risk was responsible for the U.S. stock market decline of the 1970s.