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ON THE ECONOMIC IMPACT OF MODELING NONLINEARITIES: THE ASSET PRICING EXAMPLE

Published online by Cambridge University Press:  14 December 2005

PRASAD V. BIDARKOTA
PRASAD V. BIDARKOTA
Affiliation:
Florida International University
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Abstract

We investigate the economic importance of modeling nonlinearities in the dynamics of exogenous processes on the implied moments of endogenous variables in the context of the consumption-based asset pricing model. For this purpose, we model the endowment process alternatively as a linear autoregression and as a nonlinear threshold autoregression. The asset pricing model with nonlinear endowment is solved using quadrature techniques. A comparison of the moments of the model-implied rates of return in the two cases suggests that the economic impact of modeling nonlinearities is small.

Keywords

NonlinearitiesAsset PricingNumerical Solutions
Type
ARTICLES
Information
Macroeconomic Dynamics , Volume 10 , Issue 1 , February 2006 , pp. 56 - 76
Copyright
© 2006 Cambridge University Press

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