Technological Growth, Asset Pricing, and Consumption Risk over Long Horizons

Stavros Panageas and Jianfeng Yu

No 93, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: In this paper we develop a theoretical model in order to understand comovements between asset returns and consumption over longer horizons. We develop an intertemporal general equilibrium model featuring two types of shocks: small, frequent and disembodied shocks to productivity and large technological innovations, which are embodied into new vintages of the capital stock. The latter type of shocks affect the economy with significant lags, since firms need to make irreversible investments in the new types of capital and there is an option value to waiting. The model produces endogenous cycles, countercyclical variation in risk premia, and only a very modest degree of predictability in consumption and dividend growth as observed in the data. In the model, the conventional consumption CAPM holds conditionally. Yet, by conditioning down we show that its resulting unconditional version takes a form that resembles closely the version of the CAPM used in the literature on eventual or long run risk, and most closely Juliard and Parker (2005). We then use the model as a laboratory to show that in our simulated data the unconditional consumption CAPM performs badly, while its long-horizon version performs significantly better.

Keywords: Continuous Time Asset Pricing; Long Horizons; Technology; Growth Options; Consumption CAPM (search for similar items in EconPapers)
JEL-codes: E23 G12 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (5)

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