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Asset Pricing Tests with Long Run Risks in Consumption Growth

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  • Anisha Ghosh

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  • George Constantinides

Abstract

The Bansal and Yaron (2004) model of long run risks (LLR) in aggregate consumption and dividend growth and its extension that captures potential co-integration of the consumption and dividend levels, are tested on a cross-section of asset classes and rejected using annual data over the period 1930-2006 and using both annual and quarterly data over the post-war period. The reversalof earlier empirical conclusions is partly due to the increase in the power of the tests resulting from two observations under the null. First, the latent state variables and, therefore, the pricing kernel are known affine functions of observablessuch as the interest rate and the market-wide price-dividend ratio. Second, the parameters of the time-series processes of consumption and dividend growth, theLLR variable, and its conditional variance impose constraints on the parameters of the pricing kernel. The value of the persistence parameter of the LRR variablethat best fits the data implies that its half-life is shorter than that of the business cycle.

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  • Anisha Ghosh & George Constantinides, 2008. "Asset Pricing Tests with Long Run Risks in Consumption Growth," FMG Discussion Papers dp609, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp609
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    Cited by:

    1. Roberto Marfè, 2015. "Income Insurance and the Equilibrium Term-Structure of Equity," Carlo Alberto Notebooks 407, Collegio Carlo Alberto.
    2. Na Guo & Peter N. Smith, 2012. "Durable Consumption, Long-Run Risk and The Equity Premium," Discussion Papers 12/37, Department of Economics, University of York.
    3. Roméo Tédongap, 2015. "Consumption Volatility and the Cross-Section of Stock Returns," Review of Finance, European Finance Association, vol. 19(1), pages 367-405.
    4. repec:ucp:jpolec:doi:10.1086/694621 is not listed on IDEAS
    5. Roberto Marfè, 2016. "Corporate Fraction and the Equilibrium Term Structure of Equity Risk," Review of Finance, European Finance Association, vol. 20(2), pages 855-905.
    6. Oliver Linton & Anisha Ghosh, 2007. "Consistent Estimation of the Risk-Return Tradeoff in the Presence of Measurement Error," FMG Discussion Papers dp605, Financial Markets Group.
    7. repec:eee:dyncon:v:86:y:2018:i:c:p:95-122 is not listed on IDEAS
    8. Branger, Nicole & Rodrigues, Paulo & Schlag, Christian, 2017. "Level and slope of volatility smiles in Long-Run Risk Models," SAFE Working Paper Series 186, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    9. Ravi Jagannathan & Srikant Marakani, 2011. "Price Dividend Ratio Factors : Proxies for Long Run Risk," NBER Working Papers 17484, National Bureau of Economic Research, Inc.
    10. Bakshi, Gurdip & Chabi-Yo, Fousseni, 2011. "Variance Bounds on the Permanent and Transitory Components of Stochastic Discount Factors," Working Paper Series 2011-11, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    11. Goswami, Gautam & Tan, Sinan, 2012. "Pricing the US residential asset through the rent flow: A cross-sectional study," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2742-2756.

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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