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Asset Return Dynamics Under Bad Environment-Good Environment Fundamentals

  • Bekaert, Geert
  • Engstrom, Eric

We introduce a "bad environment-good environment" technology for consumption growth in a consumption-based asset pricing model. Using the preference structure from Campbell and Cochrane (1999), the model generates realistic time-varying volatility, skewness and kurtosis in fundamentals while still permitting closed-form solutions for asset prices. The model not only fits standard salient asset prices features including means and volatilities for equity returns and risk free rates, but also generates a realistic variance premium and option prices.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8150.

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Date of creation: Dec 2010
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Handle: RePEc:cpr:ceprdp:8150
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