In this paper, we extend the long-run risks model of Bansal and Yaron (BY, 2004) to allow both
a long- and a short-run volatility component in consumption growth, long-run risks, and dividend
growth. Our two volatility model better captures macroeconomic volatility than a single volatility
model, and can reconcile simultaneously the large negative market variance risk premium, di?ering
predictability in excess returns, consumption, dividends, and stock market volatility, all of which
are di±cult to explain previously by the BY model.
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