The Econometrics of Financial Markets by John Y. Campbell & Andrew W. Lo & A. Craig MacKinlay

Author:John Y. Campbell & Andrew W. Lo & A. Craig MacKinlay [Campbell, John Y.]
Language: eng
Format: azw3
Publisher: Princeton University Press
Published: 2012-06-28T04:00:00+00:00

Time-Variation in Expected Asset Returns and Consumption Growth

Equation (8.2.5) gives a relation between rational expectations of asset returns and rational expectations of consumption growth. It implies that expected asset returns are perfectly correlated with expected consumption growth, but the standard deviation of expected asset returns is γ times as large as the standard deviation of expected consumption growth. Equivalently, the standard deviation of expected consumption growth is = 1/γ times as large as the standard deviation of expected asset returns.

This suggests an alternative way to estimate γ or . Hansen and Singleton (1983), followed by Hall (1988) and others, have proposed instrumental variables (IV) regression as a way to approach the problem. If we define an error term then we can rewrite equation (8.2.5) as a regression equation,

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