Asset Return Dynamics Under Habits and Bad-Environment Good-Environment Fundamentals

65 Pages Posted: 8 Oct 2015

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

Eric Engstrom

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: 2015-07-03

Abstract

We introduce a "bad environment-good environment" (BEGE) technology for consumption growth in a consumption-based asset pricing model with external habit formation. The model generates realistic non-Gaussian features of consumption growth and fits standard salient features of asset prices including the means and volatilities of equity returns and a low risk free rate. BEGE dynamics additionally allow the model to generate realistic properties of equity index options prices, and their comovements with the macroeconomic outlook. In particular, when option implied volatility is high, as measured for instance by the VIX index, the distribution of consumption growth is more negatively skewed.

Keywords: VIX, equity premium, habit, risk aversion, skewness

Suggested Citation

Bekaert, Geert and Engstrom, Eric C., Asset Return Dynamics Under Habits and Bad-Environment Good-Environment Fundamentals (2015-07-03). FEDS Working Paper No. 2015-53, Available at SSRN: https://ssrn.com/abstract=2670999 or http://dx.doi.org/10.2139/ssrn.2670999

Geert Bekaert (Contact Author)

Columbia Business School - Finance and Economics ( email )

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New York, NY 10027
United States

Eric C. Engstrom

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-3044 (Phone)

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