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Asset pricing lessons for modeling business cycles

  • Michele Boldrin
  • Lawrence J. Christiano
  • Jonas D. M. Fisher

We develop a model which accounts for the observed equity premium and average risk-free rate, without implying counterfactually high risk aversion. The model also does well in accounting for business-cycle phenomena. With respect to the conventional measures of business-cycle volatility and comovement with output, the model does roughly as well as the standard business-cycle model. On two other dimensions, the model’s business-cycle implications are actually improved. Its enhanced internal propagation allows it to account for the fact that there is positive persistence in output growth, and the model also provides a resolution to the “excess sensitivity puzzle” for consumption and income. Two key features of the model are habit persistence preferences and a multisector technology with limited intersectoral mobility of factors of production.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 560.

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Date of creation: 1995
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Handle: RePEc:fip:fedmwp:560
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