Working Paper: NBER ID: w15222
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: Asset Pricing; Consumption Growth; Variance Premium; Skewness; Kurtosis
JEL Codes: G10; G12; G13; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| good environment shocks (Q56) | time-varying asset return dynamics (C22) |
| bad environment shocks (Q53) | time-varying asset return dynamics (C22) |
| good environment shocks dominate (F64) | higher probability of large positive returns (G17) |
| bad environment shocks (Q53) | higher probability of large negative returns (G17) |
| variance premium (C29) | predictor of stock returns (G17) |
| variance premium (C29) | positive correlation with equity risk premium (G12) |
| risk aversion (D81) | consumption shocks (E21) |
| nonlinear consumption growth process (D15) | time-varying volatility, skewness, and kurtosis in asset returns (C58) |