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Long-Run Risk through Consumption Smoothing

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  • Georg Kaltenbrunner
  • Lars A. Lochstoer
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    Abstract

    We examine how long-run consumption risk arises endogenously in a standard production economy model where the representative agent has Epstein--Zin preferences. We show that even when technology growth is i.i.d., optimal consumption smoothing induces long-run risk--highly persistent variation in expected consumption growth. As a consequence, the model can account for a high price of risk, although both consumption growth volatility and the coefficient of relative risk aversion are low. The asset pricing implications of endogenous long-run risk depend crucially on the persistence of technology shocks and investors' preference for the timing of resolution of uncertainty. (JEL�E21, E23, E30, G12) The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

    Volume (Year): 23 (2010)
    Issue (Month): 8 (August)
    Pages: 3190-3224

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    Handle: RePEc:oup:rfinst:v:23:y:2010:i:8:p:3190-3224

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    Cited by:
    1. François Gourio, 2009. "Disasters Risk and Business Cycles," NBER Working Papers 15399, National Bureau of Economic Research, Inc.
    2. Favilukis, Jack & Lin, Xiaoji, 2012. "Long Run Productivity Risk and Aggregate Investment," Working Paper Series 2012-14, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    3. Leonid Kogan & Dimitris Papanikolaou & Noah Stoffman, 2013. "Technological Innovation: Winners and Losers," NBER Working Papers 18671, National Bureau of Economic Research, Inc.
    4. Lars-Alexander Kuehn & Nicolas Petrosky-Nadeau & Lu Zhang, 2012. "An Equilibrium Asset Pricing Model with Labor Market Search," NBER Working Papers 17742, National Bureau of Economic Research, Inc.
    5. Hakon Tretvoll, 2013. "Investment-Specific Technology Shocks and Recursive Preferences," 2013 Meeting Papers 1207, Society for Economic Dynamics.
    6. Bakshi, Gurdip & Chabi-Yo, Fousseni, 2012. "Variance bounds on the permanent and transitory components of stochastic discount factors," Journal of Financial Economics, Elsevier, vol. 105(1), pages 191-208.
    7. Pakos, Michal, 2013. "Long-Run Risk and Hidden Growth Persistence," MPRA Paper 47217, University Library of Munich, Germany.
    8. Lu Zhang & Howard Kung & Hang Bai, 2013. ""Shooting" the CAPM," 2013 Meeting Papers 905, Society for Economic Dynamics.
    9. Bakshi, Gurdip & Chabi-Yo, Fousseni, 2011. "Variance Bounds on the Permanent and Transitory Components of Stochastic Discount Factors," Working Paper Series 2011-11, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    10. Andrew Y. Chen, 2013. "External Habit in a Production Economy," 2013 Papers pch1244, Job Market Papers.
    11. Ravi Jagannathan & Srikant Marakani, 2011. "Price Dividend Ratio Factors : Proxies for Long Run Risk," NBER Working Papers 17484, National Bureau of Economic Research, Inc.

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