DP8150 Asset Return Dynamics Under Bad Environment-Good Environment Fundamentals
Author(s): | Geert Bekaert, Eric Engstrom |
Publication Date: | December 2010 |
Keyword(s): | countercyclical risk aversion, dividend yield, economic uncertainty, equity premium, return predictability, variance premium |
JEL(s): | e44, g12, g15 |
Programme Areas: | Financial Economics |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=8150 |
We introduce a "bad environment-good environment" technology for consumption growth in a consumption-based asset pricing model. Using the preference structure from Campbell and Cochrane (1999), the model generates realistic time-varying volatility, skewness and kurtosis in fundamentals while still permitting closed-form solutions for asset prices. The model not only fits standard salient asset prices features including means and volatilities for equity returns and risk free rates, but also generates a realistic variance premium and option prices.