Measuring time-varying economic fears with consumption-based stochastic discount factors
AbstractThis paper analyzes empirically the volatility of consumption-based stochastic discount factors as a measure of implicit economic fears by studying its relationship with future economic and stock market cycles. Time-varying economic fears seem to be well captured by the volatility of stochastic discount factors. In particular, the volatility of recursive utility-based stochastic discount factor with contemporaneous growth explains between 9 and 34 percent of future changes in industrial production at short and long horizons respectively. They also explain ex-ante uncertainty and risk aversion. However, future stock market cycles are better explained by a similar stochastic discount factor with long-run consumption growth. This specification of the stochastic discount factor presents higher volatility and lower pricing errors than the specification with contemporaneous consumption growth.
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Bibliographic InfoPaper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1029.
Date of creation: Apr 2007
Date of revision: Sep 2007
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Web page: http://www.econ.upf.edu/
Stochastic discount factor; economic fears; distance between probability measures; volatility of stochastic discount factor; consumption;
Find related papers by JEL classification:
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-04-21 (All new papers)
- NEP-MAC-2007-04-21 (Macroeconomics)
- NEP-UPT-2007-04-21 (Utility Models & Prospect Theory)
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