In Full-Information Estimates, Long-Run Risks Explain at Most a Quarter of P/D Variance, and Habit Explains even Less

64 Pages Posted: 1 Feb 2016 Last revised: 23 Jun 2021

See all articles by Andrew Y. Chen

Andrew Y. Chen

Board of Governors of the Federal Reserve System

Fabian Winkler

Board of Governors of the Federal Reserve System

Rebecca Wasyk

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: November 4, 2019

Abstract

Many consumption-based models succeed in matching long lists of asset price moments. We propose an alternative, full-information Bayesian evaluation that decomposes the price-dividend ratio (p/d) into contributions from long-run risks, habit, and a residual. We find that long-run risks account for less than 25% of the variance of p/d and that habit's contribution is negligible. This result is robust to the prior, including priors that assume long-run risks in consumption and highly persistent habit. However, the residual mostly tracks decades-long movements in p/d. At business cycle frequency, long-run risks explain about 70% of the movements of p/d while habit's contribution stays negligible.

Keywords: Long run risks, Rare Disasters, Habit, Bayesian Estimation, Particle Filter, Time-Varying Beliefs, Time-Varying Preferences, Excess Volatility

JEL Classification: G10, G12, E21, E30, E44, C11, C15

Suggested Citation

Chen, Andrew Y. and Winkler, Fabian and Wasyk, Rebecca, In Full-Information Estimates, Long-Run Risks Explain at Most a Quarter of P/D Variance, and Habit Explains even Less (November 4, 2019). Available at SSRN: https://ssrn.com/abstract=2724651 or http://dx.doi.org/10.2139/ssrn.2724651

Andrew Y. Chen (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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HOME PAGE: http://sites.google.com/site/chenandrewy/

Fabian Winkler

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.fabianwinkler.com

Rebecca Wasyk

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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