Consumption, the persistence of shocks, and asset price volatility [An article from: Journal of Monetary Economics]

This digital document is a journal article from Journal of Monetary Economics, published by Elsevier in 2006. The article is delivered in HTML format and is available in your Amazon.com Media Library immediately after purchase. You can view it with any web browser.

Description:
In a general equilibrium setting, a temporary component in consumption introduces a wedge between the volatility of equity returns and the volatility of consumption growth. This paper explores the asset pricing consequences of this property in a model in which consumption is the sum of a permanent and a transitory component. Permanent shocks are assumed to be rare events, while transitory shocks follow a diffusion process. When calibrated to US annual data, the model matches first and second moments of equity and bond returns for preference parameters within acceptable bounds. Permanent and transitory shocks together explain the equity premium, while transitory shocks alone explain the excess volatility of returns.