By force of confidence

Merella, Vincenzo

First

;Satchell, Stephen E.

Second

2022-01-01

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Abstract

Recent macro-finance contributions explain a great deal of unconditional asset pricing by introducing persistent consumption risks and rare disasters. Only the volatility puzzles remain unresolved among the longer-established issues in this literature. Motivated by empirical finance contributions and conventional wisdom, we abstract from a consumption-centric analysis and let the asset-pricing kernel depend on habit formation and consumer confidence as a demand shifter correlated with consumption growth. The resulting model compares favorably with the literature explaining the risk-free rate volatility. Our findings justify using supplementary information to price assets while warning against neglecting a thorough analysis of consumption growth dynamics. We rationalize including confidence indicators in the definition of the demand shifter by drawing parallels to existing approaches such as wealth in the utility function and salience theory.