Journal of Political Economy Vol. 125 No. 3 2017
Asset Return Dynamics under Habits and Bad Environment–Good Environment Fundamentals
Abstract
We introduce a “bad environment–good environment” (BEGE) technology for consumption growth in a consumption-based asset pricing model with external habit formation. The model generates realistic non-Gaussian features of consumption growth and fits standard salient features of asset prices including the means and volatilities of equity returns and a low risk-free rate. BEGE dynamics additionally allow the model to generate realistic properties of equity index options prices and their comovements with the macroeconomic outlook. In particular, when option-implied volatility is high—as measured, for instance, by the VIX index—the distribution of consumption growth is more negatively skewed.
- DOI
- 10.1086/691450
- Volume
- 125
- Issue
- 3
- Pages
- 713-760
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref