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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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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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  1. Kandel, Shmuel & Stambaugh, Robert F, 1990. "Expectations and Volatility of Consumption and Asset Returns," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 3(2), pages 207-32.
  2. Narayana R. Kocherlakota, 1995. "The equity premium: it's still a puzzle," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 102, Federal Reserve Bank of Minneapolis.
  3. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
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  6. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1429-45, November.
  7. Monique Ebell, 2000. "Why Are Asset Returns More Volatile During Recessions? A Theoretical Explanation," Computing in Economics and Finance 2000, Society for Computational Economics 355, Society for Computational Economics.
  8. Simon M. Potter, 1993. "A Nonlinear Approach to U.S. GNP," UCLA Economics Working Papers, UCLA Department of Economics 693, UCLA Department of Economics.
  9. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, Econometric Society, vol. 59(2), pages 371-96, March.
  10. 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, Elsevier, vol. 27(3), pages 399-421, January.
  11. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, Econometric Society, vol. 64(2), pages 413-30, March.
  12. Tsionas, Efthymios G., 2003. "Exact solution of asset pricing models with arbitrary shock distributions," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 27(5), pages 843-851, March.
  13. Kenneth A. Froot & Maurice Obstfeld, 1989. "Intrinsic Bubbles: The Case of Stock Prices," NBER Working Papers 3091, National Bureau of Economic Research, Inc.
  14. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, Econometric Society, vol. 57(2), pages 357-84, March.
  15. Burnside, Craig, 1998. "Solving asset pricing models with Gaussian shocks," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 22(3), pages 329-340, March.
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