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Working Paper
Asset Return Dynamics under Habits and Bad-Environment Good-Environment Fundamentals
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 ...
Working Paper
Precautionary Volatility and Asset Prices
Many theories of asset prices assume time-varying uncertainty in order to generate time-varying risk premia. This paper generates time-varying uncertainty endogenously, through precautionary saving dynamics. Precautionary motives prescribe that, in bad times, next period's consumption should be very sensitive to news. This time-varying sensitivity results in time-varying consumption volatility. Production makes this channel visible, and external habit preferences amplify it. An estimated model featuring this channel quantitatively accounts for excess return and dividend predictability ...