Consumption-Based Asset Pricing with Higher Cumulants

40 Pages Posted: 7 Jul 2010 Last revised: 20 Feb 2022

See all articles by Ian Martin

Ian Martin

London School of Economics & Political Science (LSE) - Department of Finance

Date Written: July 2010

Abstract

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.

Suggested Citation

Martin, Ian W. R., Consumption-Based Asset Pricing with Higher Cumulants (July 2010). NBER Working Paper No. w16153, Available at SSRN: https://ssrn.com/abstract=1635676

Ian W. R. Martin (Contact Author)

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/martiniw/

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