Asset Return Dynamics under Bad Environment-Good Environment Fundamentals
Coauthor(s): Eric Engstrom.
Adobe Acrobat PDF
We introduce a "bad environment-good environment" technology for consumption growth in a consumption-based asset pricing model. Using the preference structure from Campbell and Cochrane (1999), the model generates realistic time-varying volatility, skewness and kurtosis in fundamentals while still permitting closed-form solutions for asset prices. The model not only fits standard salient asset prices features including means and volatilities for equity returns and risk free rates, but also generates a realistic variance premium and option prices.
Bekaert, Geert, and Eric Engstrom. "Asset Return Dynamics under Bad Environment-Good Environment Fundamentals." Columbia Business School, July 2009.