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Why Do Asset Prices Not Follow Random Walks?

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  • Franke, Günter
  • Lüders, Erik

Abstract

This paper analyzes the e¤ect of non-constant elasticity of the pricing kernel on asset return characteristics in a rational expectations model. It is shown that declining elasticity of the pricing kernel can lead to predictability of asset returns and high and persistent volatility. Also, declining elasticity helps to motivate technical analysis and to explain stock market crashes. Moreover, based on a general characterization of the pricing kernel, we propose analytical asset price processes which can be tested empirically. The numerical analysis reveals strong deviations from the geometric Brownian motion which are caused by declining elasticity of the pricing kernel.

Suggested Citation

  • Franke, Günter & Lüders, Erik, 2004. "Why Do Asset Prices Not Follow Random Walks?," CoFE Discussion Papers 04/05, University of Konstanz, Center of Finance and Econometrics (CoFE).
    • Handle: RePEc:zbw:cofedp:0405
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    References listed on IDEAS

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    Cited by:

    1. Lüders, Erik & Lüders-Amann, Inge & Schröder, Michael, 2004. "The Power Law and Dividend Yields," ZEW Discussion Papers 04-51, ZEW - Leibniz Centre for European Economic Research.
    2. Ang, Andrew & Liu, Jun, 2007. "Risk, return, and dividends," Journal of Financial Economics, Elsevier, vol. 85(1), pages 1-38, July.

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    More about this item

    Keywords

    Pricing Kernel; Viable asset price processes; Serial correlation; Heteroskedasticity; Stock market crashes;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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