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Nonparametric Estimation of the Time-varying Sharpe Ratio in Dynamic Asset Pricing Models

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Author Info
Peter Woehrmann
Willi Semmler
Martin Lettau

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Abstract

Economic research of the last decade linking macroeconomic fundamentals to asset prices has revealed evidence that standard intertemporal asset pricing theory is not successful in explaining (unconditional) ¯rst moments of asset market characteristics such as the risk-free interest rate, equity premium and the Sharpe-ratio. Subsequent empirical research has pursued the question whether those characteristics of asset markets are time varying and, in particular, varying over the business cycle. Recently intertemporal asset pricing models have been employed to replicate those time varying characteristics. The aim of our contribution is (1) to relax some of the assumptions that previous work has imposed on underlying economic and ¯nancial vari- ables, (2) to extend the solution technique of Marcet and Den Haan (1990) for those models by nonparametric expectations and (3) to propose a new estimation procedure based on the above solution technique. To allow for nonparametric expectations in the expectations approach for numerically solving the intertemporal economic model we employ the Local Linear Maps (LLMs) of Ritter, Martinetz and Schulten (1992) to approximate conditional expectations in the Euler equation. In our estimation approach based on non-parametric expectations we are able to use full structural information and, consequently, Monte Carlo simulations show that our estimations are less biased than the widely applied GMM procedure. Based on quarterly U.S. data we also empirically estimate structural parameters of the model and explore its time varying asset price characteristics for two types of preferences, power utility and habit persistence.

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Paper provided by Institute for Empirical Research in Economics - IEW in its series IEW - Working Papers with number iewwp225.

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Handle: RePEc:zur:iewwpx:225

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Related research
Keywords: Nonparametric; Estimation; Time-varying Sharpe Ratio; Asset Pricing;

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Find related papers by JEL classification:
C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General
G1 - Financial Economics - - General Financial Markets

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  3. Fehr, Ernst & Kremhelmer, Susanne & Schmidt, Klaus M., 2005. "Fairness and the Optimal Allocation of Ownership Rights," CEPR Discussion Papers 5369, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  4. Alois Stutzer & Lukas Kienast, 2004. "Demokratische Beteiligung und Staatsausgaben: Die Auswirkungen des Frauenstimmrechts," CREMA Working Paper Series 2004-26, Center for Research in Economics, Management and the Arts (CREMA). [Downloadable!]
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Fehr, Ernst & Singer, Tania, 2005. "The Neuroconomics of Mind Reading and Empathy," CEPR Discussion Papers 5128, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Philipp C. Wichardt & Pavlo R. Blavatskyy, . "Base-Rate Neglect and Imperfect Information Acquisition," IEW - Working Papers iewwp233, Institute for Empirical Research in Economics - IEW. [Downloadable!]
  3. Falk, Armin & Fehr, Ernst & Zehnder, Christian, 2005. "The Behavioural Effects of Minimum Wages," CEPR Discussion Papers 5115, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  4. Fehr, Ernst & Fischbacher, Urs & Kosfeld, Michael, 2005. "Neuroeconomic Foundation of Trust and Social Preferences," CEPR Discussion Papers 5127, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  5. Salvador Barberà & Anke Gerber, . "A Note on the Impossibility of a Satisfactory Concept of Stability for Coalition Formation Games," IEW - Working Papers iewwp238, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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  6. Margit Osterloh & Bruno S. Frey, . "Shareholders Should Welcome Employees as Directors," IEW - Working Papers iewwp228, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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  7. Anke Gerber, . "Learning in and about Games," IEW - Working Papers iewwp234, Institute for Empirical Research in Economics - IEW. [Downloadable!]
  8. Peter Woehrmann, . "A dynamic model of the financial–real interaction as a model selection criterion for nonparametric stock market prediction," IEW - Working Papers iewwp226, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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This page was last updated on 2009-12-17.

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