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Zhiguang (Gerald) Wang, Prasad V. Bidarkota, A Long-Run Risks Model of Asset Pricing with Fat Tails, Review of Finance, Volume 14, Issue 3, July 2010, Pages 409–449, https://doi.org/10.1093/rof/rfp015
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Abstract
We explore the effects of fat tails on the equilibrium implications of the long-run risks model of asset pricing by introducing innovations with dampened power law to consumption and dividends growth processes. We estimate the model structural parameters by maximum likelihood. We find that the stochastic volatility model with fat tails can generate implied risk premium, expected risk free rate and their volatilities comparable to the magnitudes observed in data. The model with fat tails leads to a significant increase in implied risk premia over the benchmark Gaussian model, but similar values for other equilibrium quantities of interest.