Asset prices with non-permanent shocks to consumption

Walt Pohl (), Karl Schmedders and Ole Wilms

Journal of Economic Dynamics and Control, 2016, vol. 69, issue C, 152-178

Abstract: Most standard asset-pricing models assume that all shocks to consumption are permanent. We relax this assumption and allow also for non-permanent shocks. In our specification, the long-run mean of consumption growth is constant; consumption levels are subject to short-run deviations from their long-run trend. The implications of our model are dramatically different from those obtained in the prior literature. A canonical and parsimonious asset pricing model with CRRA preferences and non-permanent shocks can reproduce the equity premium, high return volatility and return predictability with a coefficient of relative risk aversion below ten. This finding suggests that non-permanent shocks can play an important role in explaining asset pricing puzzles.

Keywords: Asset prices; Equity premium; Unit root; Non-permanent shocks (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:69:y:2016:i:c:p:152-178

DOI: 10.1016/j.jedc.2016.05.010

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