Asset Pricing Tests with Long Run Risks in Consumption Growth

George Constantinides and Anisha Ghosh

No 14543, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: A novel methodology in testing the long-run risks model of Bansal and Yaron (2004) is presented based on the observation that, under the null, the potentially latent state variables, "long-run risk" and the conditional variance of its innovation, are known a¢ ne functions of the observable market-wide price-dividend ratio and risk free rate. In linear forecasting regressions of consumption growth and returns by the price-dividend ratio and risk free rate, the model implies much higher forecastability than what is observed in the data over 1931 -2009. The co-integrated variant of the model by Bansal, Gallant, and Tauchen (2007), also implies much higher forecastability of returns than what is observed in the data. Finally, we reject the models' implications in jointly pricing the cross-section of returns and fitting the unconditional time series moments of consumption and dividend growth. The results suggest that either some important state variable is missing or that the models should be generalized in a way that the lagged price-dividend ratio and risk free enter the regressions in a non-linear fashion.

JEL-codes: G12 (search for similar items in EconPapers)
Date: 2008-12
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Published as George M. Constantinides & Anisha Ghosh, 2011. "Asset Pricing Tests with Long-run Risks in Consumption Growth," Review of Asset Pricing Studies, vol 1(1), pages 96-136.

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Related works:
Journal Article: Asset Pricing Tests with Long-run Risks in Consumption Growth (2011)
Working Paper: Asset pricing tests with long run risks in consumption growth (2008)
Working Paper: Asset Pricing Tests with Long Run Risks in Consumption Growth (2008)
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