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Asset prices with non-permanent shocks to consumption

Author

Listed:
  • Pohl, Walter
  • Schmedders, Karl
  • Wilms, Ole
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.

Suggested Citation

  • Pohl, Walter & Schmedders, Karl & Wilms, Ole, 2016. "Asset prices with non-permanent shocks to consumption," Journal of Economic Dynamics and Control, Elsevier, vol. 69(C), pages 152-178.
    • Handle: RePEc:eee:dyncon:v:69:y:2016:i:c:p:152-178
    DOI: 10.1016/j.jedc.2016.05.010
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    References listed on IDEAS

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    More about this item

    Keywords

    Asset prices; Equity premium; Unit root; Non-permanent shocks;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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