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Long-Run Risk through Consumption Smoothing

  • Georg Kaltenbrunner
  • Lars A. Lochstoer
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    We examine how long-run consumption risk arises endogenously in a standard production economy model where the representative agent has Epstein--Zin preferences. We show that even when technology growth is i.i.d., optimal consumption smoothing induces long-run risk--highly persistent variation in expected consumption growth. As a consequence, the model can account for a high price of risk, although both consumption growth volatility and the coefficient of relative risk aversion are low. The asset pricing implications of endogenous long-run risk depend crucially on the persistence of technology shocks and investors' preference for the timing of resolution of uncertainty. (JEL�E21, E23, E30, G12) The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/rfs/hhq033
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    Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

    Volume (Year): 23 (2010)
    Issue (Month): 8 (August)
    Pages: 3190-3224

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    Handle: RePEc:oup:rfinst:v:23:y:2010:i:8:p:3190-3224
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