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
March 15, 2011
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.
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, E44working papers series
Date posted: March 18, 2011
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