TY - JOUR
AU - Dew-Becker,Ian
AU - Giglio,Stefano
TI - Asset Pricing in the Frequency Domain: Theory and Empirics
JF - National Bureau of Economic Research Working Paper Series
VL - No. 19416
PY - 2013
Y2 - September 2013
DO - 10.3386/w19416
UR - http://www.nber.org/papers/w19416
L1 - http://www.nber.org/papers/w19416.pdf
N1 - Author contact info:
Ian Dew-Becker
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston, IL 60208
E-Mail: ian.dewbecker@gmail.com
Stefano Giglio
University of Chicago
Booth School of Business
5807 S. Woodlawn Avenue
Chicago, IL 60637
Tel: 773/834-1957
E-Mail: stefano.giglio@chicagobooth.edu
AB - In affine asset pricing models, the innovation to the pricing kernel is a function of innovations to current and expected future values of an economic state variable, for example consumption growth, aggregate market returns, or short-term interest rates. The impulse response of this priced variable to fundamental shocks has a frequency (Fourier) decomposition, which captures the fluctuations induced in the priced variable at different frequencies. We show that the price of risk for a given shock can be represented as a weighted integral over that spectral decomposition. The weight assigned to each frequency then represents the frequency-specific price of risk, and is entirely determined by the preferences of investors. For example, standard Epstein-Zin preferences imply that the weight of the pricing kernel lies almost entirely at extremely low frequencies, most of it on cycles longer than 230 years; internal habit-formation models imply that the weight is shifted to high frequencies. We estimate the frequency-specific risk prices for the equity market, focusing on economically interesting frequencies. Most of the pricing weight falls on low frequencies - corresponding to cycles longer than 8 years - broadly consistent with Epstein-Zin preferences.
ER -