Applying the Calibration Approach

Abstract

The application of the variance bound approach in the previous chapter has given a first impression of the capability of the different parametric models of the market pricing kernel to jointly price different assets. Now, the calibration approach described in chapter 5 is applied to quarterly German data for the period 1960 to 1994. The goal is to analyze, whether the parametric models of the market pricing kernel derived from time-additive expected utility and, alternatively, derived from recursive non-expected utility can be calibrated to match the first and second moments of the empirically observed risk-free rate and equity premium. The “benchmark returns” that are to be matched are those calculated for the four taxation scenarios (see table 6.8). Different modifications of the original approach of Mehra and Prescott (1985) discussed in section 5.3 are investigated.