Measuring Time-Varying Economic Fears with Consumption-Based Stochastic Discount Factors

38 Pages Posted: 26 Jul 2007

See all articles by Belen Nieto

Belen Nieto

University of Alicante

Gonzalo Rubio

University of the Basque Country - Department of Foundations of Economic Analysis I

Date Written: April 2007

Abstract

This paper analyzes empirically the volatility of consumption-based stochastic discount factors as a measure of implicit economic fears by studying its relationship with future economic and stock market cycles. Time-varying economic fears seem to be well captured by the volatility of stochastic discount factors. In particular, the volatility of recursive utility-based stochastic discount factor with contemporaneous growth explains between 9 and 34 percent of future changes in industrial production at short and long horizons respectively. They also explain ex-ante uncertainty and risk aversion. However, future stock market cycles are better explained by a similar stochastic discount factor with long-run consumption growth. This specification of the stochastic discount factor presents higher volatility and lower pricing errors than the specification with contemporaneous consumption growth.

Keywords: Stochastic discount factor, economic fears, distance between probability measures, volatility of stochastic discount factor, consumption

JEL Classification: G10, G12, E44

Suggested Citation

Nieto, Belen and Rubio, Gonzalo A., Measuring Time-Varying Economic Fears with Consumption-Based Stochastic Discount Factors (April 2007). Available at SSRN: https://ssrn.com/abstract=1003126 or http://dx.doi.org/10.2139/ssrn.1003126

Belen Nieto

University of Alicante ( email )

Campus de San Vicente
Carretera San Vicente del Raspeig
San Vicente del Raspeig, Alicante 03690
Spain

Gonzalo A. Rubio (Contact Author)

University of the Basque Country - Department of Foundations of Economic Analysis I ( email )

Avda. Lehendakari Aguirre 83
Bilbao, Vizcaya 48015 48015
Spain
+34 94 601 3770 (Phone)
+34 94 601 3774 (Fax)

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