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On the Economic Impact of Modeling Non-Linearities: The Asset Pricing Example

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  • Prasad Bidarkota

    () (Department of Economics, Florida International University)

Abstract

We investigate the economic importance of modeling non-linearities in the dynamics of exogenous processes on the implied moments of endogenous variables in the context of the consumption-based asset pricing model. For this purpose, we model the endowment process alternatively as a linear autoregression and as a non-linear threshold autoregression. The asset pricing model with non-linear endowment is solved using quadrature techniques. A comparison of the moments of the model-implied rates of return in the two cases suggests that the economic impact of modeling non-linearities is less than 0.01 percent per annum.

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File URL: http://casgroup.fiu.edu/pages/docs/2248/1280267794_03-05.pdf
File Function: First version, 2003
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Bibliographic Info

Paper provided by Florida International University, Department of Economics in its series Working Papers with number 0305.

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Length: 28 pages
Date of creation: Nov 2003
Date of revision:
Publication status: Forthcoming in Macroeconomic Dynamics
Handle: RePEc:fiu:wpaper:0305

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Postal: Miami, FL 33199
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Fax: (305) 348-1524
Web page: http://casgroup.fiu.edu/Economics/
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Keywords: asset pricing; rates of return; non-linearities; threshold autoregressions; numerical solutions;

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  9. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March.
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  11. Neftci, Salih N, 1984. "Are Economic Time Series Asymmetric over the Business Cycle?," Journal of Political Economy, University of Chicago Press, vol. 92(2), pages 307-28, April.
  12. Bidarkota, Prasad V. & McCulloch, J. Huston, 2003. "Consumption asset pricing with stable shocks--exploring a solution and its implications for mean equity returns," Journal of Economic Dynamics and Control, Elsevier, vol. 27(3), pages 399-421, January.
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