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The Size of the Permanent Component of Asset Pricing Kernels

Fernando Alvarez and Urban Jermann

Working Papers from University of Pennsylvania, Wharton School, Weiss Center

Abstract: We derive a lower bound for the size of the permanent component of asset pricing kernels. The bound is based on return properties of long-term zero-coupon bonds, risk-free bonds, and other risky securities. We find the permanent component of the pricing kernel to be very large; its volatility is about the same as the volatility of the stochastic discount factor. We also show that, for many cases where the pricing kernel is a function of consumption, innovations to consumption need to have permanent effects.

Date: 2001-11
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