The Structure of Social Risk

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Discussion Paper

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It is increasingly recognized that the structure of financial risks interacts with economic or fundamental risks in a way that influence real economic outcomes. Recent work documents, on the one hand, the apparent excessive sensitivity of financial markets to economic shocks (see especially Shiller (1979)); and on the other hand the close dependence of investment and economic variables on financial variables. One of the central developments to analyze such interactions has been portfolio theory, particularly the capital asset pricing model (CAPM). This field has been extremely fertile, and has seen an outpouring of both theoretical and empirical work. Unfortunately, virtually all the work has been directed at a very narrow set of concerns — stock market performance. Thus virtually every major firm has been extensively studied and has its own “beta” estimates from numerous beta vendors. To our knowledge, however, there has been no attempt to apply these tools to the economy.

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