Asset Prices with Non-Permanent Shocks to Consumption

44 Pages Posted: 15 Jun 2014 Last revised: 7 Dec 2018

See all articles by Walt Pohl

Walt Pohl

NHH Norwegian School of Economics; University of Zurich

Karl Schmedders

University of Zurich

Ole Wilms

Tilburg School of Economics and Management

Date Written: August 19, 2016

Abstract

Most standard asset-pricing models assume that all shocks to consumption are permanent. We relax this assumption and allow also for non-permanent shocks. In our specification, the long-run mean of consumption growth is constant; consumption levels are subject to short-run deviations from their long-run trend. The implications of our model are dramatically different from those obtained in the prior literature. A canonical and parsimonious asset pricing model with CRRA preferences and non-permanent shocks can reproduce the equity premium, high return volatility and return predictability with a coefficient of relative risk aversion below ten. This finding suggests that non-permanent shocks can play an important role in explaining asset pricing puzzles.

Keywords: Asset prices, equity premium, unit root, non-permanent shocks.

JEL Classification: G11, G12.

Suggested Citation

Pohl, Walt and Schmedders, Karl and Wilms, Ole, Asset Prices with Non-Permanent Shocks to Consumption (August 19, 2016). Swiss Finance Institute Research Paper No. 14-41. Available at SSRN: https://ssrn.com/abstract=2450090 or http://dx.doi.org/10.2139/ssrn.2450090

Walt Pohl

NHH Norwegian School of Economics ( email )

Helleveien 30
N-5045 Bergen
Norway

University of Zurich ( email )

Moussonstrasse 15
Zürich, 8044
Switzerland

Karl Schmedders (Contact Author)

University of Zurich ( email )

Moussonstrasse 15
Zürich, CH-8044
Switzerland
+41 (0)44 634 3770 (Phone)

Ole Wilms

Tilburg School of Economics and Management ( email )

PO Box 90153
Tilburg, 5000 LE Ti
Netherlands

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