A New Variance Bound on the Stochastic Discount Factor
AbstractIn this paper, we construct a new variance bound on any stochastic discount factor (SDF) of the form m = m(x), with x being a vector of state variables, which tightens the well-known Hansen-Jagannathan bound by a ratio of one over the multiple correlation coefficient between x and the standard minimum variance SDF, m0. In many applications, the correlation is small, and hence the bound is much improved. For example, when x is the growth rate of consumption, the new variance bound can be 25 times greater than the Hansen-Jagannathan bound, making it much more difficult to explain the equity-premium puzzle.
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Bibliographic InfoArticle provided by University of Chicago Press in its journal Journal of Business.
Volume (Year): 79 (2006)
Issue (Month): 2 (March)
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Web page: http://www.journals.uchicago.edu/JB/
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- Fousseni Chabi-Yo & René Garcia & Eric Renault, 2005. "The Stochastic Discount Factor: Extending the Volatility Bound and a New Approach to Portfolio Selection with Higher-Order Moments," Working Papers 05-2, Bank of Canada.
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