Testing Long-Run-Risk Model With Simulated Moment Method

Consumption-based asset pricing model(CCAPM) has been one of the main accom-plishments in the field of financial economics in the past thirty more years. However, in the empirical study, the CCAPM with high expectations perform poorly and couldn’ t solve the three classical mystery in financial market, such as "equity premium puz-zle","the risk-free rate puzzle","the equity volatility puzzle".The Long-Run-Risk model (Bansal, Yaron(2004)) was proposed based on the Equity-Premium Puzzle and the Risk-free Puzzle which can’t be explained.The most important point of this model is that the consumption growth rate and dividend growth rate are time-varying with long-run risk. So it added an unobservable variable xt which is the long-run risk fator in the con-sumption. As a result, this model explains perfetly the Equity-Premium Puzzle and the Risk-free Puzzle. However, there’s a lot of debate about whether Long-Run-Risk model is true. So we use EMSE to test whether xt affects consumption growth rate and dividend growth rate, based on that xt exits, in order to know whether the Long-Run-Risk model is true.