Asset Prices and Time-Varying Risk

Observers have often characterized asset markets as being subject to periods of tranquility and periods of turbulence. Until recently, however, researchers were unable to produce closed-form asset pricing formulas in a model environment of time-varying risk. Some work by Abel provided us with the insights needed to produce such formulas. This paper gives an exposition of how to develop the formulas in an, environment where the formulas may be obtained using a simple extension of standard tools. While the paper is intended mainly as an exposition of new work, it also contains a report on the asset market effect of fiscal reform. IC is found that entering a period of week coordination between government spending end taxing (tax rate) policy is good for stock prices.