Working Paper: CEPR ID: DP8150
Authors: Geert Bekaert; Eric Engstrom
Abstract: We introduce a "bad environment-good environment" technology for consumption growth in a consumption-based asset pricing model. Using the preference structure from Campbell and Cochrane (1999), the model generates realistic time-varying volatility, skewness and kurtosis in fundamentals while still permitting closed-form solutions for asset prices. The model not only fits standard salient asset prices features including means and volatilities for equity returns and risk free rates, but also generates a realistic variance premium and option prices.
Keywords: Countercyclical risk aversion; Dividend yield; Economic uncertainty; Equity premium; Return predictability; Variance premium
JEL Codes: E44; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Consumption growth shocks (F62) | Equity premium (G19) |
| Higher volatility in consumption (D11) | Increased precautionary savings (E21) |
| Increased precautionary savings (E21) | Lower risk-free rates (G19) |
| Variance premium (G19) | Time-varying skewness and kurtosis (C22) |