Asset prices with non-permanent shocks to consumption

Walter Pohl, Karl Schmedders, Ole Wilms

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Most standard asset-pricing models assume that all shocks to consumption are permanent. We relax this assumption and allow also for non-permanent shocks. In our specification, the long-run mean of consumption growth is constant; consumption levels are subject to short-run deviations from their long-run trend. The implications of our model are dramatically different from those obtained in the prior literature. A canonical and parsimonious asset pricing model with CRRA preferences and non-permanent shocks can reproduce the equity premium, high return volatility and return predictability with a coefficient of relative risk aversion below ten. This finding suggests that non-permanent shocks can play an important role in explaining asset pricing puzzles.
Original languageEnglish
Pages (from-to)152-178
JournalJournal of Economic Dynamics and Control
Volume69
DOIs
Publication statusPublished - Aug 2016
Externally publishedYes

Keywords

  • Asset prices
  • Equity premium
  • Unit root
  • Non-permanent shocks

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