In the past decade Japanese households have been buffeted by some big aggregate shocks.
Economic growth has slowed, unemployment risk has risen, and asset prices have fallen
to levels not seen since the early 1980's. These shocks have hit both households' financial
and human capital. This paper develops a framework for identifying the sources of these
shocks and a way to measure how household assessments of these risks vary over time.
We consider the perspective of a forward-looking risk-averse household and derive
expected returns and time-varying risk premia for each risk factor. We then construct
times-series of historical expected risk premia using Japanese data on industry returns.
An analysis of this data provides four main findings. First, prior to 1984 expected risk
premia on identified goods market shocks, monetary policy and financial market risk are
all important determinants of industry level expected returns. Second, starting in 1984
households perceive that the risk from financial shocks is increasing and demand higher
risk premia to hold this risk. Third, between 1987 and 1990 risk premia on monetary
policy are large and positive. Monetary policy is perceived to be adding to financial risk.
Fourth, in 1990 as expected risk premia on financial risk shoot up, expected risk premia
on monetary policy shocks turn negative for all industry returns. As stock prices collapse
between 1990 and 1995, monetary policy shocks play an important role in hedging risk
emanating from the financial sector. |