Semiparametric Estimation of Latent Variable Asset Pricing Models

Abstract

This paper studies semiparametric identification and estimation of the stochastic
discount factor in consumption-based asset pricing models with latent state variables.
We model consumption, dividends, and a multiplicative discount factor component
via unknown functions of Markovian states describing aggregate output growth. For
the case of affine state dynamics and polynomial approximation of the measurement
and pricing equations, we provide rank conditions for identification and tractable
algorithms for filtering, smoothing, and likelihood estimation. Empirically, we find
sizable nonlinearities and interactions in the impacts of expected growth and volatility
on the price-dividend ratio and the discount factor.

Keywords: Asset Prices, Volatility, Risk Aversion, Latent Variables, Semiparametric Estimation

JEL Classification: C14, C58, G12