Abstract

http://ssrn.com/abstract=1364107
 
 

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Asset Pricing with Left-Skewed Long-Run Risk in Durable Consumption


Wei Yang


Indiana University - Department of Finance

April 9, 2010

Simon School Working Paper No. FR 09-09
AFA 2010 Atlanta Meetings Paper

Abstract:     
I document that durable consumption growth is persistent and predicted by the price-dividend ratio. This provides strong and direct evidence for the existence of a highly persistent expected component. I also document robust evidence that durable consumption growth is left skewed and exhibits time-varying volatility. Based on these empirical properties, I model durable consumption growth as containing a persistent expected component and driven by shocks with counter-cyclical volatility. I embed the durable consumption growth dynamics and random walk nondurable consumption growth in nonseparable Epstein-Zin preferences, and model dividend growth as a levered claim on the expected component of durable consumption growth. The resulting model can explain a number of asset pricing phenomena, including pro-cyclical price-dividend ratios, large and counter-cyclical equity premia and stock return volatilities, low and smooth risk-free rates, and the predictability of stock returns. The model also generates the volatility feedback effect and an upward sloping term structure of real bond yields.

Number of Pages in PDF File: 55

Keywords: Skewness, Long-Run Risk, Durable Consumption, Equity Premium Puzzle

JEL Classification: G12

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Date posted: March 24, 2009 ; Last revised: April 13, 2010

Suggested Citation

Yang, Wei, Asset Pricing with Left-Skewed Long-Run Risk in Durable Consumption (April 9, 2010). Simon School Working Paper No. FR 09-09; AFA 2010 Atlanta Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1364107 or http://dx.doi.org/10.2139/ssrn.1364107

Contact Information

Wei Yang (Contact Author)
Indiana University - Department of Finance ( email )
1309 E. 10th St.
Bloomington, IN 47405
United States
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