Peso Problems in the Estimation of the C-CAPM

59 Pages Posted: 14 Jul 2021

See all articles by Juan Carlos Parra-Alvarez

Juan Carlos Parra-Alvarez

Aalborg University Business School

Olaf Posch

Universität Hamburg, Department of Economics; CREATES

Andreas Schrimpf

CREATES - Aarhus University; Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: June 1, 2021

Abstract

This paper shows that the consumption-based capital asset pricing model (C-CAPM) with low probability disaster risk rationalizes pricing errors. We find that implausible estimates of risk aversion and time preference are not puzzling if market participants expect a future catastrophic change in fundamentals, which just happens not to occur in the sample (a ‘peso problem’). A bias in structural parameter estimates emerges as a result of pricing errors in quiet times. While the bias essentially removes the pricing error in the simple models when risk-free rates are constant, time-variation may also generate large and persistent estimated pricing errors in simulated data. We also show analytically how the problem of biased estimates can be avoided in empirical research by resolving the misspecification in moment conditions.

JEL Classification: E21, G12, O41

Suggested Citation

Parra-Alvarez, Juan Carlos and Posch, Olaf and Schrimpf, Andreas and Schrimpf, Andreas, Peso Problems in the Estimation of the C-CAPM (June 1, 2021). CEPR Discussion Paper No. DP16299, Available at SSRN: https://ssrn.com/abstract=3886772

Juan Carlos Parra-Alvarez (Contact Author)

Aalborg University Business School ( email )

Fibigerstræde 2
Aalborg Ø, 9220
Denmark

Olaf Posch

Universität Hamburg, Department of Economics ( email )

Von-Melle-Park 5
Hamburg, 20146
Germany

CREATES

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

CREATES - Aarhus University ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
0
Abstract Views
90
PlumX Metrics