Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/24637 
Authors: 
Year of Publication: 
2002
Series/Report no.: 
ZEW Discussion Papers No. 02-48
Publisher: 
Zentrum für Europäische Wirtschaftsforschung (ZEW), Mannheim
Abstract: 
Starting from an information process governed by a geometric Brownian motion we show that asset returns are predictable if the elasticity of the pricing kernel is not constant. Declining [Increasing] elasticity of the pricing kernel leads to mean reversion and negatively autocorrelated asset returns [mean aversion and positively autocorrelated asset returns]. Under nonconstant elasticity of the pricing kernel financial ratios as the price-earnings ratio have predictive power for future asset returns. In addition, it is shown that asset prices will be governed by a time-homogeneous stochastic differential equation only under the constant elasticity pricing kernel. Hence, usually asset price processes do not satisfy the assumptions needed for empirical estimation.
Subjects: 
Pricing kernel
Diffusion processes
Stationarity
Predictability of asset returns
Autocorrelation
JEL: 
G12
Document Type: 
Working Paper

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