Rational Pessimism, Rational Exuberance, and Asset Pricing Models

Ravi Bansal, A. Gallant and George Tauchen ()

No 13107, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The paper estimates and examines the empirical plausibiltiy of asset pricing models that attempt to explain features of financial markets such as the size of the equity premium and the volatility of the stock market. In one model, the long run risks model of Bansal and Yaron (2004), low frequency movements and time varying uncertainty in aggregate consumption growth are the key channels for understanding asset prices. In another, as typified by Campbell and Cochrane (1999), habit formation, which generates time-varying risk-aversion and consequently time-variation in risk-premia, is the key channel. These models are fitted to data using simulation estimators. Both models are found to fit the data equally well at conventional significance levels, and they can track quite closely a new measure of realized annual volatility. Further scrutiny using a rich array of diagnostics suggests that the long run risk model is preferred.

JEL-codes: G0 G00 G1 G10 G12 (search for similar items in EconPapers)
Date: 2007-05
New Economics Papers: this item is included in nep-bec and nep-dge
Note: AP
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Citations: View citations in EconPapers (77)

Published as Ravi Bansal & A. Ronald Gallant & George Tauchen, 2007. "Rational Pessimism, Rational Exuberance, and Asset Pricing Models," Review of Economic Studies, Blackwell Publishing, vol. 74(4), pages 1005-1033, October.

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