Asset Return Dynamics Under Bad Environment-Good Environment Fundamentals

52 Pages Posted: 27 Dec 2010

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

Eric Engstrom

U.S. Board of Governors of the Federal Reserve System - Division of Research and Statistics, Capital Markets

Multiple version iconThere are 4 versions of this paper

Date Written: December 2010

Abstract

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.

Keywords: countercyclical risk aversion, dividend yield, economic uncertainty, equity premium, return predictability, variance premium

JEL Classification: E44, G12, G15

Suggested Citation

Bekaert, Geert and Engstrom, Eric C., Asset Return Dynamics Under Bad Environment-Good Environment Fundamentals (December 2010). CEPR Discussion Paper No. DP8150. Available at SSRN: https://ssrn.com/abstract=1729569

Geert Bekaert (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Eric C. Engstrom

U.S. Board of Governors of the Federal Reserve System - Division of Research and Statistics, Capital Markets ( email )

20th & C. St., N.W.
Washington, DC 20551
United States
202-452-3044 (Phone)

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