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Extreme Inflation and Time-Varying Expected Consumption Growth

Author

Listed:
  • Ilya Dergunov

    (Research School of Finance, Actuarial Studies and Statistics, Australian National University, Acton, ACT 2601, Australia)

  • Christoph Meinerding

    (Deutsche Bundesbank, Research Centre, 60431 Frankfurt am Main, Germany; Faculty of Economics and Business, Goethe University Frankfurt, and Leibniz Institute for Financial Research SAFE, 60323 Frankfurt am Main, Germany)

  • Christian Schlag

    (Faculty of Economics and Business, Goethe University Frankfurt, and Leibniz Institute for Financial Research SAFE, 60323 Frankfurt am Main, Germany)

Abstract
In a parsimonious regime switching model, we find strong evidence that expected consumption growth varies over time. Adding inflation as a second variable, we uncover two states in which expected consumption growth is low, one with high and one with negative expected inflation. Embedded in a general equilibrium asset pricing model with learning, these dynamics replicate the observed time variation in stock return volatilities and stock-bond return correlations. They also provide an alternative derivation for a measure of time-varying disaster risk suggested by Watcher [ Wachter J (2013 ) Can time-varying risk of rare disasters explain aggregate stock market volatility? J. Finance 68(3):987–1035]. implying that both the disaster and the long-run risk paradigm can be extended toward explaining movements in the stock-bond correlation.

Suggested Citation

  • Ilya Dergunov & Christoph Meinerding & Christian Schlag, 2023. "Extreme Inflation and Time-Varying Expected Consumption Growth," Management Science, INFORMS, vol. 69(5), pages 2972-3002, May.
    • Handle: RePEc:inm:ormnsc:v:69:y:2023:i:5:p:2972-3002
    DOI: 10.1287/mnsc.2022.4451
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    Cited by:

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    2. Ermolov, Andrey, 2022. "Time-varying risk of nominal bonds: How important are macroeconomic shocks?," Journal of Financial Economics, Elsevier, vol. 145(1), pages 1-28.

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    More about this item

    Keywords

    long-run risk; inflation; recursive utility; filtering; disaster risk;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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