Why Do Asset Prices Not Follow Random Walks?

Günter Franke () and Erik Lüders ()
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Günter Franke: Department of Economics, University of Konstanz
Erik Lüders: Pinehill Capital and Laval University

No 04-05, CoFE Discussion Paper from Center of Finance and Econometrics, University of Konstanz

Abstract: This paper analyzes the e¤ect of non-constant elasticity of the pricing kernel on asset return characteristics in a rational expectations model. It is shown that declining elasticity of the pricing kernel can lead to predictability of asset returns and high and persistent volatility. Also, declining elasticity helps to motivate technical analysis and to explain stock market crashes. Moreover, based on a general characterization of the pricing kernel, we propose analytical asset price processes which can be tested empirically. The numerical analysis reveals strong deviations from the geometric Brownian motion which are caused by declining elasticity of the pricing kernel.

Keywords: Pricing Kernel; Viable asset price processes; Serial correlation; Heteroskedasticity; Stock market crashes (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-ets, nep-fin and nep-fmk
Date: Written 2004-08-18
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