Trend Growth Shocks and Asset Prices
69 Pages Posted: 25 Jan 2019 Last revised: 13 Nov 2019
Date Written: January 25, 2019
This paper addresses the link between shocks to productivity trend growth and long-run consumption risk in a production economy model with recursive utility. Quantifying trend growth shocks, I find that persistent fluctuations in trend growth are the key driver of sizable long-run consumption risk. I compare this result to two conventional assumptions on a productivity process: 1) a deterministic trend with a cycle and 2) a random walk with drift. Persistent trend growth shocks generate larger long-run consumption risk than both highly persistent cycle shocks and random walk shocks. As a result, agents in the face of the trend growth shocks tend to save more and demand a higher equity premium. In addition, fluctuations in aggregate productivity growth is largely attributable to movements in trend growth.
Keywords: Long-run consumption risk, stochastic trend growth, equity premium, production economy, exact initial Kalman filter
JEL Classification: E21, E23, E30, G12
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