A Two-Step Indirect Inference Approach to Estimate the Long-Run Risk Asset Pricing Model
76 Pages Posted: 20 Sep 2017 Last revised: 16 Jan 2018
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 macroeconomic 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
Suggested Citation: Suggested Citation