Asset Pricing in the Frequency Domain: Theory and Empirics

Ian Dew-Becker and Stefano Giglio

No 19416, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In affine asset pricing models, the innovation to the pricing kernel is a function of innovations to current and expected future values of an economic state variable, for example consumption growth, aggregate market returns, or short-term interest rates. The impulse response of this priced variable to fundamental shocks has a frequency (Fourier) decomposition, which captures the fluctuations induced in the priced variable at different frequencies. We show that the price of risk for a given shock can be represented as a weighted integral over that spectral decomposition. The weight assigned to each frequency then represents the frequency-specific price of risk, and is entirely determined by the preferences of investors. For example, standard Epstein-Zin preferences imply that the weight of the pricing kernel lies almost entirely at extremely low frequencies, most of it on cycles longer than 230 years; internal habit-formation models imply that the weight is shifted to high frequencies. We estimate the frequency-specific risk prices for the equity market, focusing on economically interesting frequencies. Most of the pricing weight falls on low frequencies - corresponding to cycles longer than 8 years - broadly consistent with Epstein-Zin preferences.

JEL-codes: E2 E21 G0 G1 G12 (search for similar items in EconPapers)
Date: 2013-09
New Economics Papers: this item is included in nep-mac
Note: AP EFG
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Citations: View citations in EconPapers (12)

Published as Ian Dew-Becker & Stefano Giglio, 2016. "Asset Pricing in the Frequency Domain: Theory and Empirics," Review of Financial Studies, Society for Financial Studies, vol. 29(8), pages 2029-2068.

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Journal Article: Asset Pricing in the Frequency Domain: Theory and Empirics (2016)
Working Paper: Asset pricing in the frequency domain: theory and empirics (2013)
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