Extreme inflation and time-varying expected consumption growth

  • In a parsimonious regime switching model, we find strong evidence that expected consumption growth varies over time. Adding inflation as a second variable, we uncover two states in which expected consumption growth is low, one with high and one with negative expected inflation. 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. They also provide an alternative derivation for a measure of time-varying disaster risk suggested by Wachter (2013), implying that both the disaster and the long-run risk paradigm can be extended towards explaining movements in the stock-bond correlation.

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Author:Ilya Dergunov, Christoph MeinerdingORCiDGND, Christian SchlagORCiDGND
Parent Title (English):SAFE working paper ; No. 334
Series (Serial Number):SAFE working paper (334)
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2022
Year of first Publication:2022
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2022/01/10
Tag:Long-run risk; disaster risk; filtering; inflation; recursive utility
Issue:This version: January 3, 2022
Page Number:88
Another version of this paper is available at: Dergunov, Ilya and Meinerding, Christoph and Schlag, Christian, Extreme Inflation and Time-Varying Expected Consumption Growth (April 2, 2019). Available at SSRN: https://ssrn.com/abstract=2832845 or http://dx.doi.org/10.2139/ssrn.2832845
We gratefully acknowledge research and financial support from the Leibniz Center for Financial Research SAFE (formerly Research Center SAFE, funded by the State of Hessen initiative for research LOEWE).
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / House of Finance (HoF)
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht