Scandinavian Working Papers in Economics

Working Papers,
Copenhagen Business School, Department of Finance

No 2004-7: Latent Utility Shocks in a Structural Empirical Asset Pricing Model

Bent Jesper Christensen and Peter Raahauge
Additional contact information
Bent Jesper Christensen: Department of Finance, Copenhagen Business School, Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
Peter Raahauge: Department of Finance, Copenhagen Business School, Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark

Abstract: We consider a random utility extension of the fundamental Lucas (1978) equilibrium asset pricing model. The resulting structural model leads naturally to a likelihood function. We estimate the model using U.S. asset market data from 1871 to 2000, using both dividends and earnings as state variables. We find that current dividends do not forecast future utility shocks, whereas current utility shocks do forecast future dividends. The estimated structural model produces a sequence of predicted utility shocks which provide better forecasts of future long-horizon stock market returns than the classical dividend-price ratio.

Keywords: Randomutility; asset pricing; maximumlikelihood; structuralmodel; return predictability

JEL-codes: G00

36 pages, December 14, 2004

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