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Asset Return Dynamics under Habits and Bad Environment-Good Environment Fundamentals

Geert Bekaert () and Eric Engstrom

Journal of Political Economy, 2017, vol. 125, issue 3, 713 - 760

Abstract: We introduce a "bad environment-good environment" (BEGE) technology for consumption growth in a consumption-based asset pricing model with external habit formation. The model generates realistic non-Gaussian features of consumption growth and fits standard salient features of asset prices including the means and volatilities of equity returns and a low risk-free rate. BEGE dynamics additionally allow the model to generate realistic properties of equity index options prices and their comovements with the macroeconomic outlook. In particular, when option-implied volatility is high--as measured, for instance, by the VIX index--the distribution of consumption growth is more negatively skewed.

Date: 2017
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Working Paper: Asset Return Dynamics under Habits and Bad-Environment Good-Environment Fundamentals (2015) Downloads
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Handle: RePEc:ucp:jpolec:doi:10.1086/691450