Extreme Inflation and Time-Varying Consumption Growth
57 Pages Posted: 16 Apr 2019
Date Written: 2019
In a parsimonious regime switching model, expected consumption growth varies over time. Adding in ation as a conditioning variable, we uncover two states in which expected consumption growth is low, one with high and one with negative expected in ation. Embedded in a general equilibrium asset pricing model with learning, these dynamics replicate the observed time variation in stock return volatilities and stock-bond return correlations. Furthermore, they provide an alternative way to come up with a measure of time-varying disaster risk in the spirit of Wachter (2013). Our findings imply that both the disaster and the long-run risk paradigm can be extended towards explaining movements in the stock-bond return correlation.
Keywords: long-run risk, inflation, recursive utility, filtering, disaster risk
JEL Classification: E31, E44, G12
Suggested Citation: Suggested Citation