A Two-Step Indirect Inference Approach to Estimate the Long-Run Risk Asset Pricing Model
73 Pages Posted: 10 Aug 2016 Last revised: 27 May 2017
Date Written: May 27, 2017
The long-run consumption risk model provides a theoretically appealing explanation for prominent asset pricing puzzles, but its intricate structure presents a challenge for econometric analysis. This paper proposes a two-step indirect inference approach that disentangles the estimation of the model's macro-economic dynamics and the investor's preference parameters. A Monte Carlo study explores the feasibility and efficiency of the estimation strategy. We apply the method to recent U.S.\data and provide a critical re-assessment of the long-run risk model's ability to reconcile the real economy and financial markets. This two-step indirect inference approach is potentially useful for the econometric analysis of other prominent consumption-based asset pricing models that are equally difficult to estimate.
Keywords: indirect inference estimation, asset pricing, long-run risk
JEL Classification: C58, G10, G12
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