High Aversion to Stochastic Time Preference Shocks and Counterfactual Long-Run Risk in the Albuquerque et al., Valuation Risk Model

We study the effects of market incompleteness on speculation, investor survival, and asset pricing moments when investors disagree about the likelihood of jumps and have recursive preferences. We consider two models. In a model with jumps in aggregate consumption, incompleteness barely matters because the consumption claim resembles an insurance product against jump risk and effectively reproduces approximate spanning. In a long-run risk model with jumps in the long-run growth rate, market incompleteness affects speculation and investor survival. Jump and diffusive risks are more balanced regarding their importance, and therefore the consumption claim cannot reproduce approximate spanning.

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TESTING THE LONG-RUN RISK MODEL: A KALMAN FILTER APPROACH

Annals of Financial Economics ◽

10.1142/s2010495218500197 ◽

2018 ◽

Vol 13 (04) ◽

pp. 1850019

Author(s):

JIANQIU WANG ◽

KE WU

Keyword(s):

Kalman Filter ◽

Maximum Likelihood ◽

Risk Model ◽

Estimation Method ◽

Model Performance ◽

Empirical Support ◽

Likelihood Estimation ◽

Long Run ◽

Filter Approach ◽

Long Run Risk

This paper reevaluates the Long-Run Risk model proposed by Bansal and Yaron (2004) using the Kalman filter and Maximum Likelihood estimation method. Our findings show that the persistence of the small long-run predictable component in the consumption growth process is the key for the model performance. In our estimation exercises, if we relax the persistence restriction on the long-run risk parameter and adopt a Maximum Likelihood estimate, the Long-Run Risk model still requires a relative risk aversion at around 70 to fit the US data. However, we do not find strong empirical support for the persistence restriction from the data.

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The Term Structures of Coentropy in International Financial Markets

Management Science ◽

10.1287/mnsc.2017.3017 ◽

2019 ◽

Vol 65 (8) ◽

pp. 3541-3558 ◽

Cited By ~ 6

Author(s):

Fousseni Chabi-Yo ◽

Riccardo Colacito

Keyword(s):

Financial Markets ◽

Risk Model ◽

Discount Factors ◽

Model Free ◽

Term Structures ◽

Asset Pricing Models ◽

Long Run ◽

Stochastic Discount Factors ◽

Permanent And Transitory Components ◽

Long Run Risk

We propose a new entropy-based correlation measure (coentropy) to evaluate the performance of international asset pricing models. Coentropy captures the codependence of two random variables beyond normality. We document that the coentropy of international stochastic discount factors (SDFs) can be decomposed into a series of entropy-based correlations of permanent and transitory components of the SDFs. We employ the cross section of G-10 countries to obtain model-free estimates of all the components of coentropy at various horizons and we show that the generalization of the long-run risk model featuring two predictable components of consumption growth rates, global disasters, and recursive preferences can account for the composition of codependence at all horizons. This paper was accepted by Tomasz Piskorski, finance.

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Efficient bond price approximations in non-linear equilibrium-based term structure models

Studies in Nonlinear Dynamics & Econometrics ◽

10.1515/snde-2012-0005 ◽

2015 ◽

Vol 19 (1) ◽

pp. 1-33 ◽

Cited By ~ 2

Author(s):

Martin M. Andreasen ◽

Pawel Zabczyk

Keyword(s):

Term Structure ◽

Risk Model ◽

Bond Price ◽

Third Order ◽

Approximation Process ◽

Long Run ◽

The Us ◽

Normal Method ◽

Log Normal ◽

Long Run Risk

AbstractThis paper develops an efficient method to compute higher-order perturbation approximations of bond prices. At third order, our approach can significantly shorten the approximation process and its precision exceeds the log-normal method and a procedure using consol bonds. The efficiency gains greatly facilitate any estimation which is illustrated by considering a long-run risk model for the US. Allowing for an unconstrained intertemporal elasticity of substitution enhances the model’s fit, and we see further improvements when incorporating stochastic volatility and external habits.

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