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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. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
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  7. Kandel, Shmuel & Stambaugh, Robert F, 1990. "Expectations and Volatility of Consumption and Asset Returns," Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 207-32.
  8. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Intrinsic Bubbles: The Case of Stock Prices," American Economic Review, American Economic Association, vol. 81(5), pages 1189-214, December.
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  11. 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.
  12. Tsionas, Efthymios G., 2003. "Exact solution of asset pricing models with arbitrary shock distributions," Journal of Economic Dynamics and Control, Elsevier, vol. 27(5), pages 843-851, March.
  13. Burnside, Craig, 1998. "Solving asset pricing models with Gaussian shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 22(3), pages 329-340, March.
  14. Simon M. Potter, 1993. "A Nonlinear Approach to U.S. GNP," UCLA Economics Working Papers 693, UCLA Department of Economics.
  15. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
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