Give Me Strong Moments and Time: Combining GMM and SMM to Estimate the Long-Run Risk Asset Pricing Model

Abstract

The long-run consumption risk (LRR) model is a popular approach to resolve various asset pricing puzzles, but its econometric analysis is complicated and often relies on simulation-based methods. This study addresses inherent identification problems and offers a solution by proposing a two-step GMM/SMM estimation strategy that exploits the recursive LRR model structure. We motivate macroeconomic and financial moment matches and show possibilities and limits for a successful econometric analysis of the LRR model. A simulation study and an empirical application reveal the estimation quality, in terms of feasibility and precision, that reasonably can be expected.

Keywords: asset pricing, long-run risk, simulation-based estimation

JEL Classification: G10, G12, C58