Consumption-Based Asset Pricing with Higher Cumulants
I extend the Epstein-Zin-lognormal consumption-based asset-pricing model to allow for general i.i.d. consumption growth. Information about the higher moments--equivalently, cumulants--of consumption growth is encoded in the cumulant-generating function. I apply the framework to economies with rare disasters, and argue that the importance of such disasters is a double-edged sword: parameters that govern the frequency and sizes of rare disasters are critically important for asset pricing, but extremely hard to calibrate. I show how to sidestep this issue by using observable asset prices to make inferences that are robust to the details of the underlying consumption process.
First draft: 20 August, 2006. I thank Dave Backus, Robert Barro, Emmanuel Farhi, Xavier Gabaix, Simon Gilchrist, Francois Gourio, Greg Mankiw, Anthony Niblett, Jeremy Stein, Adrien Verdelhan, Martin Weitzman and, in particular, John Campbell for their comments. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
Ian W. Martin, 2013. "Consumption-Based Asset Pricing with Higher Cumulants," Review of Economic Studies, Oxford University Press, vol. 80(2), pages 745-773. citation courtesy of