Research On Asset Pricing Model Under Inflation Risk And Its Application

Consumption capital asset pricing model tells us the relation between financial market and macro economy. It is initiated that finance studies merge into equilibrium economy framework. The model seeks the hidden financial market risks from macro economy, and tries to solve the problem that capital asset pricing model can't answer. The uncertainty is the origin of the problem. The styled facts however don't support the model."Equity premium puzzle"and other anomalies haunted by the model have been incensing many financial economists to solve the problem and boost the development of consumption capital asset pricing model under the stochastic discount factor framework (SDF).As the framework application, Euler equation (SDF) shows the consumer's (investor) intertemporal optimal choice behavior, i.e. two kinds of resource allocation behavior. First, the investor can hedge risk from the macro economy, which is the question about portfolio choice or asset allocation. Second, when the consumers'future consumption or savings is affected by shock from macro factor's variation, they can show precautionary savings. How to explain and reduce the resident precautionary savings behavior is the key to consumption theory.Inflation is not a simple measure relation between real economy and nominal economy. The inflation uncertainty has on influences on both the micro agents and capital market. And its uncertainty risk can be easily estimated by the data. In macro views, inflation is a controlled index, and policy makers can regulate it. In micro views, it is convenient for investors to hedge the risk to realize the optimal portfolio allocation. Thus we can investigate asset pricing in equilibrium, asset allocation considering inflation risk under consumption asset pricing framework, and precautionary savings behavior under uncertain inflation. Moreover the ways to reduce precautionary savings are discussed.The main contents and conclusions are summarized as follows:1,Asset pricing theory, asset allocation, consumption and savings behavior under Neo-classical economics analysis framework are summarized. The origin of the theory is uncertainty. The uniform analysis framework is first order Euler equation, i.e. a common stochastic discount factor, which shows essentially the relation between macro economy and financial market. The above-mentioned researches give reasonable explanation from the micro views. 2,Asset pricing model considering inflation risk discusses the relation between financial market(risky asset) and macro economy(consumption and inflation). Strategic asset allocation under inflation hedging is analyzed according to the investor's performance. The above-mentioned studies are sum up to the performance of financial market and participants.(1) Asset pricing model considering inflation risk is set up, and extend the consumption asset pricing model under recursive utility, which is the framework of the whole dissertation. The asset pricing model considering inflation risk is induced after considering real purchase power's influence on consumption and investment and introducing the price index into the recursive utility function. In other words, we find a new stochastic discount factor. Then a model including three beta factors as market, consumption and inflation is built up in pricing equation. Hedgy asset against inflation such as real estate can ask for low risk premium, while assets such as stock that has negative correlation with inflation for high risk premium. Thus, we can say, inflation risk premium can explain equity premium puzzle to some degree. And the Euler pricing equation is the base of dynamic asset allocation and precautionary savings in following chapters.(2) The empirical study about the asset pricing model under inflation risk is conducted. First the equity premium puzzle about Sino-USA markets is comparatively analyzed using Hansen-Jagannathan variance bound method. The conclusions are drawn that there is no stronger robust equity premium puzzle in China than in USA market. Then the asset pricing model under inflation risk is tested, comparing with the asset pricing model under recursive utility function and basic consumption asset pricing. The finding is that asset pricing model under inflation risk has a stronger power to explain the equity premium in China market. No matter how to choose parameter, risk aversion value belongs to [1.22,3.03]. Many economists think the value is reasonable that does not resulting in equity risk puzzle, so the explain power is robust.(3) Strategic asset allocation hedging against inflation risk is set up. Following the chapter three, using Campbell-Virceira log linear approximate method, a new asset allocation model is built up. Inflation risk is a state variable of bond price, and it also can influence other financial assets and non-financial assets. So investor's optimal asset allocation can be satisfied when there is myopic demand and investor's intertemporal hedge demands including that hedge demand against investment opportunity set due interest rate unfavorable shift and against inflation unfavorable change.3,Under the stochastic discount factor framework considering inflation risk, the relationship between riskless asset and consumption is discussed, and the uncertainty source resulting in precautionary savings is analyzed with a view to the consumers'saving behavior. Not only the existing of the precautionary saving is tested, but also the way to reduce precautionary savings is discussed. (1) Residential precautionary savings model under uncertain inflation is discussed, which is the application of the theory framework built up in chapter three. Precautionary savings model under uncertain inflation risk is induced and empirically tested follow the asset pricing considering inflation risk. Inflation uncertainty in China is estimated by GARCH (1, 1). The regression between inflation uncertainty and city residential consumption expenditure is set up. The finding is that consumers facing inflation risk at present and lag one period can reduce the consumption expenditure, and the interest rate has no influences on consumption as expected. Then the cause behind precautionary savings under inflation risk is the uncertain income and expenditure under uncertain inflation, and liquidity constrained due to uncertain inflation.(2) The ways to reduce the precautionary saving are discussed. Precautionary savings is an inefficient way to resource allocation, so it is necassary to reduce it. According to the analysis of the inflation uncertainty's transfer channel to precautionary, two ways are put forth. One is that the inflation maintains stable. The other is that uncertainty consumption such as medical expenditure is insured by government, and social medical insurance can crowd out the precautionary savings. A two-period model is built up and simulated to analyses the"crowd out"effect. If government takes on 1% medical expenditure, then crowd out savings accounts for 1.6-1.7% of the per capita income, and consumption increases by 2% per capita consumption. In micro views, if social medical insurance is implemented, household consumption will increase at present and precautionary savings will decrease. In macro view, high savings in China can decrease and social medical insurance can be improved, which can increase internal consumption.The primary innovation in this dissertation is demonstrated as follows:1,Asset pricing model under inflation risk is produced. This is a three factors model including the consumption, market and inflation beta that priced the relative risk. The asset pricing model under inflation is tested using Hansen-Jagannathan variance bound method.The model answers the question about the relation between financial market and macro economy variable like consumption and inflation. The key to the question is a new stochastic discount factor including inflation factor in our model. Then the asset pricing model under inflation risk is tested using China's data. Comparing with the asset pricing model based on recursive utility without considering inflation risk and basic consumption asset pricing, the asset pricing model considering inflation risk has stronger expositive power, which shows the result is robust.2,When long-term investors maximize their portfolio choice and consider the inflation risk as the background risk, they can hedge against inflation risk. From this point a strategic asset allocation model hedging against inflation risk is built up.We use Campbell-Viceira method to solve the Merton's problem and think the inflation risk is the risk that investor must hedge. The asset allocation model is extended on the Campbell and Viceira (2002) model.3,Precautionary saving model under uncertain inflation is set up to investigate the influence that the inflation risk has on household consumption and saving behavior. Then the model is empirically tested using the city residential consumption data.Based on the asset pricing model framework under the inflation risk, the relation between risk-free asset and consumption is discussed. The precautionary saving model under uncertain inflation is set up. The empirical conclusion is drawn that China's city residents show precautionary savings behavior when facing the uncertain inflation. And interest rate elasticity to consumption is close to zero. When residents show the precautionary savings, the macro regulate using the interest rate tool is restrained to some degree, and keeping the stable inflation may be an effective way to increase household consumption.4,The uncertain medical expenditures insured by the government have"crowd out"effect on precautionary savings. The crowd out effect is modeled and numerically analyzed. The macro policy effect of the institutional hedgy risk arrangement is a good choice.A two-period model is built and simulated to analyze the"crowd out"effect. Implementation of social medical insurance can reduce the risk that economic agent faces, and have effects on the household choice about consuming and savings/investment, then produce"crowd out"effect on household saving. From macro effect's prospective, comprehensive implementation of social medical plan can reduce the anxiety about present high savings. In the meantime substituting institutional arrangement to avoid risk for self-finance way of precautionary savings can improve the whole social welfare and abate the present bad medical insurance status in China.