Variance Bounds on the Permanent and Transitory Components of Stochastic Discount Factors
University of Maryland - Robert H. Smith School of Business
Ohio State University (OSU) - Fisher College of Business
December 20, 2011
Journal of Financial Economics (JFE), Forthcoming
Charles A. Dice Center Working Paper No. 2011-11
Fisher College of Business Working Paper No. 2011-03-011
In this paper, we develop lower bounds on the variance of the permanent component and the transitory component, and on the variance of the ratio of the permanent to the transitory components of SDFs. Exactly solved eigenfunction problems are then used to study the empirical attributes of asset pricing models that incorporate long-run risk, external habit persistence, and rare disasters. Specific quantitative implications are developed for the variance of the permanent and the transitory components, the return behavior of the long-term bond, and the comovement between the transitory and the permanent components of SDFs.
Number of Pages in PDF File: 41
Keywords: Stochastic discount factors, permanent component, transitory component, variance bounds, asset pricing models, eigenfunction problems
JEL Classification: G11, G12, G13, C5, D24, D34
Date posted: June 21, 2011 ; Last revised: February 18, 2012
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