How Does Stochastic Volatility Influence Asset Prices? – A Parameter-Free Approach

32 Pages Posted: 9 Mar 2018

See all articles by Janis Müller

Janis Müller

Technical University of Dortmund

Peter N. Posch

TU Dortmund University

Date Written: February 26, 2018

Abstract

We disentangle the risk of time-varying volatility and return in a consumption-based asset pricing model by introducing stochastic volatility of consumption growth to asset prices moving in volatility units instead of moving in time. This time-change approach yields additional insights to risk premia’s composition. We explore stochastic volatility empirically where it eases the risk-free rate puzzle and solves the equity premium puzzle if people are very impatient. As a factor it significantly improves the explanation of returns in the cross-section and is not captured by existing factors. Adding our factor helps to explain the momentum effect among other anomalies.

Keywords: Stochastic volatility, Consumption-based asset pricing, Factor models, Time-change

JEL Classification: G12, E21, C38

Suggested Citation

Müller, Janis and Posch, Peter N., How Does Stochastic Volatility Influence Asset Prices? – A Parameter-Free Approach (February 26, 2018). Available at SSRN: https://ssrn.com/abstract=3130008 or http://dx.doi.org/10.2139/ssrn.3130008

Janis Müller (Contact Author)

Technical University of Dortmund ( email )

Emil-Figge-Straße 50
Dortmund, 44227
Germany

Peter N. Posch

TU Dortmund University ( email )

Otto Hahn Str. 6
Dortmund, 44227
Germany

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