Working Paper: NBER ID: w13107
Authors: Ravi Bansal; A. Ronald Gallant; George Tauchen
Abstract: The paper estimates and examines the empirical plausibiltiy of asset pricing models that attempt to explain features of financial markets such as the size of the equity premium and the volatility of the stock market. In one model, the long run risks model of Bansal and Yaron (2004), low frequency movements and time varying uncertainty in aggregate consumption growth are the key channels for understanding asset prices. In another, as typified by Campbell and Cochrane (1999), habit formation, which generates time-varying risk-aversion and consequently time-variation in risk-premia, is the key channel. These models are fitted to data using simulation estimators. Both models are found to fit the data equally well at conventional significance levels, and they can track quite closely a new measure of realized annual volatility. Further scrutiny using a rich array of diagnostics suggests that the long run risk model is preferred.
Keywords: asset pricing; equity premium; volatility; long-run risks; habit formation
JEL Codes: G00; G1; G10; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| consumption growth (E20) | asset prices (G19) |
| time-varying uncertainty (D84) | asset prices (G19) |
| low-frequency movements in consumption growth (E20) | asset prices (G19) |
| high-frequency consumption movements (E21) | risk premia (G22) |
| LRR model (C59) | consumption beta of market returns (E21) |
| HAB model (C59) | consumption beta of market returns (E21) |
| LRR model (C59) | risk-return relationship (G11) |