Robust Aggregate Implications of Stochastic Discount Factor Volatility

Casey B. Mulligan

NBER Working Paper No. 10210
Issued in January 2004
NBER Program(s):   EFG   AP

The stochastic discount factor seems volatile, but is this observation of any consequence for aggregate analysis of consumption, capital accumulation, output, etc.? I amend the standard frictionless model of aggregate consumption and capital accumulation with time-varying subjective probability adjustments, and obtain four implications for aggregate economic analysis. First, subjective probability adjustments add volatility to the stochastic discount factor, and can rationalize any pattern of asset prices satisfying no-arbitrage, even while capital accumulation is efficient. Second, despite its flexibility in pricing assets, the model implies that, in expected value, the intertemporal marginal rate of transformation is equal to the intertemporal marginal rate of substitution, and there is a simple, stable, and familiar relation between consumption growth and capital's return. Third, the expected returns on assets in small net aggregate supply are weakly (and sometimes negatively) correlated with capital's expected return, and are thereby poor predictors of aggregate consumption growth. Fourth, when it comes to assets in small net aggregate supply, capital gains reflect time varying risk premia, and returns can predict aggregate consumption growth better when the capital gain component of those returns is ignored. All four implications are consistent with empirical results reported here, and in the previous literature documenting stochastic discount factor volatility. Several recent theories of stochastic discount factor volatility can, from the aggregate point of view, be interpreted as special cases of subjective probability adjusted CCAPM.

download in pdf format
   (352 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w10210

Users who downloaded this paper also downloaded* these:
Mulligan w9373 Capital, Interest, and Aggregate Intertemporal Substitution
Cochrane and Hansen w4088 Asset Pricing Explorations for Macroeconomics
Burnside w16634 Identification and Inference in Linear Stochastic Discount Factor Models with Excess Returns
Mulligan w10262 What do Aggregate Consumption Euler Equations Say about the Capital Income Tax Burden?
Mulligan w9374 Capital Tax Incidence: First Impressions from the Time Series
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us