Asset Return Dynamics under Bad Environment-Good Environment Fundamentals
Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)
U.S. Board of Governors of the Federal Reserve System - Division of Research and Statistics, Capital Markets
June 21, 2010
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 non-Gaussian features of 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 realistic features of the "risk-neutral" conditional densitiy of equity returns, including the variance premium.
Number of Pages in PDF File: 50
Keywords: Equity premium, variance premium, Countercyclical risk aversion, Economic Uncertainty, Dividend yield, Return predictability
JEL Classification: G12, G15, E44
Date posted: July 31, 2009 ; Last revised: June 28, 2011
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