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Identifying long-run risks: a bayesian mixed-frequency approach

  • Frank Schorfheide
  • Dongho Song
  • Amir Yaron

We develop a nonlinear state-space model that captures the joint dynamics of consumption, dividend growth, and asset returns. Building on Bansal and Yaron (2004), our model consists of an economy containing a common predictable component for consumption and dividend growth and multiple stochastic volatility processes. The estimation is based on annual consumption data from 1929 to 1959, monthly consumption data after 1959, and monthly asset return data throughout. We maximize the span of the sample to recover the predictable component and use high-frequency data, whenever available, to efficiently identify the volatility processes. Our Bayesian estimation provides strong evidence for a small predictable component in consumption growth (even if asset return data are omitted from the estimation). Three independent volatility processes capture different frequency dynamics; our measurement error specification implies that consumption is measured much more precisely at an annual than monthly frequency; and the estimated model is able to capture key asset-pricing facts of the data.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 13-39.

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Date of creation: 2013
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Handle: RePEc:fip:fedpwp:13-39
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  1. Beeler, Jason & Campbell, John Y., 2012. "The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment," Critical Finance Review, now publishers, vol. 1(1), pages 141-182, January.
  2. Andreasen, Martin M., 2010. "Stochastic volatility and DSGE models," Economics Letters, Elsevier, vol. 108(1), pages 7-9, July.
  3. Wilcox, David W, 1992. "The Construction of U.S. Consumption Data: Some Facts and Their Implications for Empirical Work," American Economic Review, American Economic Association, vol. 82(4), pages 922-41, September.
  4. Rui Albuquerque & Martin S. Eichenbaum & Sergio Rebelo, 2012. "Valuation Risk and Asset Pricing," NBER Working Papers 18617, National Bureau of Economic Research, Inc.
  5. S. Boragan Aruoba & Francis X. Diebold & Chiara Scotti, 2007. "Real-time measurement of business conditions," International Finance Discussion Papers 901, Board of Governors of the Federal Reserve System (U.S.).
  6. Robert F. Stambaugh, 1999. "Predictive Regressions," NBER Technical Working Papers 0240, National Bureau of Economic Research, Inc.
  7. Ravi Bansal & Robert F. Dittmar & Christian T. Lundblad, 2005. "Consumption, Dividends, and the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 60(4), pages 1639-1672, 08.
  8. Robert J. Barro, 2009. "Rare Disasters, Asset Prices, and Welfare Costs," American Economic Review, American Economic Association, vol. 99(1), pages 243-64, March.
  9. Ravi Bansal & Amir Yaron, 2000. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," NBER Working Papers 8059, National Bureau of Economic Research, Inc.
  10. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
  11. Frank Schorfheide & Dongho Song, 2012. "Real-time forecasting with a mixed-frequency VAR," Working Papers 701, Federal Reserve Bank of Minneapolis.
  12. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  13. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
  14. Chernov, Mikhail & Gallant, A. Ronald & Ghysels, Eric & Tauchen, George, 2002. "Alternative Models for Stock Price Dynamic," Working Papers 02-03, Duke University, Department of Economics.
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