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Consumption-based asset pricing with higher cumulants

Martin, I. W. R. (2013) Consumption-based asset pricing with higher cumulants. The Review of Economic Studies, 80 (2). pp. 745-773. ISSN 0034-6527

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Abstract

I extend the Epstein–Zin-lognormal consumption-based asset-pricing model to allow for general i.i.d. consumption growth. Information about the higher moments—equivalently, cumulants—of consumption growth is encoded in the cumulant-generating function. I use the framework to analyse economies with rare disasters, and argue that the importance of such disasters is a double-edged sword: parameters that govern the frequency and sizes of rare disasters are critically important for asset pricing, but extremely hard to calibrate. I show how to sidestep this issue by using observable asset prices to make inferences without having to estimate higher moments of the underlying consumption process. Extensions of the model allow consumption to diverge from dividends, and for non-i.i.d. consumption growth.

Item Type: Article
Official URL: http://restud.oxfordjournals.org/
Additional Information: © 2012 The Author
Library of Congress subject classification: H Social Sciences > HG Finance
Journal of Economic Literature Classification System: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
G - Financial Economics > G1 - General Financial Markets > G10 - General
Sets: Departments > Finance
Collections > Economists Online
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Date Deposited: 22 Apr 2013 08:54
URL: http://eprints.lse.ac.uk/49785/

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