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A two-step indirect inference approach to estimate the long-run risk asset pricing model

Joachim Grammig and Eva-Maria Küchlin

Journal of Econometrics, 2018, vol. 205, issue 1, 6-33

Abstract: The long-run consumption risk model provides a theoretically appealing explanation for prominent asset pricing puzzles, but its intricate structure presents a challenge for econometric analysis. This paper proposes a two-step indirect inference approach that disentangles the estimation of the model’s macro-economic dynamics and the investor’s preference parameters. A Monte Carlo study explores the feasibility and efficiency of the estimation strategy. We apply the method to recent U.S. data and provide a critical re-assessment of the long-run risk model’s ability to reconcile the real economy and financial markets. This two-step indirect inference approach is potentially useful for the econometric analysis of other prominent consumption-based asset pricing models that are equally difficult to estimate.

Keywords: Indirect inference estimation; Asset pricing; Long-run risk (search for similar items in EconPapers)
JEL-codes: C58 G10 G12 (search for similar items in EconPapers)
Date: 2018
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