Discussion paper

DP8150 Asset Return Dynamics Under Bad Environment-Good Environment Fundamentals

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.

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Citation

Bekaert, G and E Engstrom (eds) (2010), “DP8150 Asset Return Dynamics Under Bad Environment-Good Environment Fundamentals”, CEPR Press Discussion Paper No. 8150. https://cepr.org/publications/dp8150