Working Paper: NBER ID: w29085
Authors: Mikhail Chernov; Lars A. Lochstoer; Dongho Song
Abstract: We present evidence that the mix of transitory and permanent shocks to consumption is changing over time. We identify three regimes: two highly persistent regimes where either permanent or transitory shocks are relatively more dominant, and a disaster regime that is largely transitory. We study implications of this finding for asset prices. The transition from the second to the first regime in the mid-1990s makes the correlation between equities and bonds switch sign from positive to negative as in the data. The real bond and equity yield curves are approximately flat. The nominal bond curve is upward sloping. These results are achieved without relying on the nominal channel too much. That is, as in the data, the variation of inflation in the model is under 40% as a fraction of variation in nominal yields.
Keywords: Consumption Dynamics; Asset Pricing; Bond-Stock Correlation
JEL Codes: E32; E43; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| permanent shocks to consumption (E21) | correlation between stock and bond returns (G12) |
| transitory shocks to consumption (D15) | correlation between stock and bond returns (G12) |
| negative shocks to consumption in permanent regime (E21) | lower-than-average growth (O49) |
| negative shocks to consumption in transitory regime (E21) | higher-than-average growth (O49) |
| transitory shocks in disaster regime (H84) | recoveries of real bonds (G12) |
| permanent component dominance (D10) | positive covariance between realized and expected consumption growth (F62) |
| transitory component dominance (E32) | negative covariance between realized and expected consumption growth (E21) |
| correlation between consumption claims and real bond returns switches sign (D15) | dynamics of consumption components (E20) |
| model generates realistic baseline asset-pricing moments (G19) | robustness of causal claims (C22) |