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Asset prices with non-permanent shocks to consumption


Schmedders, Karl; Wilms, Ole; Pohl, Walter (2016). Asset prices with non-permanent shocks to consumption. Journal of Economic Dynamics and Control, 69:152-178.

Abstract

Most standard asset-pricing models assume that all shocks to consumption are permanent. We relax this assumption and allow also for non-permanent shocks. In our specification, the long-run mean of consumption growth is constant; consumption levels are subject to short-run deviations from their long-run trend. The implications of our model are dramatically different from those obtained in the prior literature. A canonical and parsimonious asset pricing model with CRRA preferences and non-permanent shocks can reproduce the equity premium, high return volatility and return predictability with a coefficient of relative risk aversion below ten. This finding suggests that non-permanent shocks can play an important role in explaining asset pricing puzzles.

Abstract

Most standard asset-pricing models assume that all shocks to consumption are permanent. We relax this assumption and allow also for non-permanent shocks. In our specification, the long-run mean of consumption growth is constant; consumption levels are subject to short-run deviations from their long-run trend. The implications of our model are dramatically different from those obtained in the prior literature. A canonical and parsimonious asset pricing model with CRRA preferences and non-permanent shocks can reproduce the equity premium, high return volatility and return predictability with a coefficient of relative risk aversion below ten. This finding suggests that non-permanent shocks can play an important role in explaining asset pricing puzzles.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Business Administration
Dewey Decimal Classification:330 Economics
Language:English
Date:1 August 2016
Deposited On:17 Nov 2016 14:20
Last Modified:10 Sep 2017 15:40
Publisher:Elsevier
ISSN:0165-1889
Publisher DOI:https://doi.org/10.1016/j.jedc.2016.05.010
Other Identification Number:merlin-id:14008

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Embargo till: 2019-08-31