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Federal Reserve Bank of Dallas
Working Papers
Campbell and Cochrane meet Melino and Yang: reverse engineering the surplus ratio in a Mehra-Prescott economy
James Dolmas
Abstract

The habit model of Campbell and Cochrane (1999) specifies a process for the 'surplus ratio'-the excess of consumption over habit, relative to consumption-rather than an evolution for the habit stock. It's not immediately apparent if their formulation can be accommodated within the Markov chain framework of Mehra and Prescott (1985). This note illustrates one way to create a Campbell and Cochrane-like model within the Mehra-Prescott framework. A consequence is that we can perform another sort of reverse-engineering exercize-we can calibrate the resulting model to match the stochastic discount factor derived in the Mehra-Prescott framework by Melino and Yang (2003). The Melino-Yang SDF, combined with Mehra and Prescott's consumption process, yields asset returns that exactly match the first and second moments of the data, as estimated by Mehra and Prescott.> >


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James Dolmas, Campbell and Cochrane meet Melino and Yang: reverse engineering the surplus ratio in a Mehra-Prescott economy, Federal Reserve Bank of Dallas, Working Papers 1205, 2012.
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Keywords: Financial markets; Asset pricing
DOI: 10.24149/wp1205
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