Asset Pricing with Idiosyncratic Risk and Overlapping Generations

Kjetil Storesletten (), Chris Telmer and Amir Yaron ()

No 3065, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Constantines and Duffie (1996) show that for Idiosyncratic risk to matter for asset pricing the shocks must (i) be highly persistent and (ii) become more volatile during economic contractions. We show that data from the Panel Study on Income Dynamics (PSID) are consistent with these requirements. Our results are based on econometric methods that incorporate macroeconomic information going beyond the time horizon of the PSID, dating back to 1910. We go on to argue that life-cycle effects are fundamental for how idiosyncratic risk affects asset pricing. We use a stationary overlapping-generations model to show that life-cycle effects can either mitigate or accentuate the equity premium, the critical ingredient being whether agents accumulate or deccumulate risky assets as they age. Our model predicts the latter and is able to account for both the average equity premium and the Sharpe ratio observed on the US stock market.

Keywords: life-cycle effects; PSID (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2001-11
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Related works:
Working Paper: Asset Pricing with Idiosyncratic Risk and Overlapping Generations (1999)
Working Paper: Asset pricing with idiosyncratic risk and overlapping generations (2002)
Working Paper: Asset pricing with idiosyncratic risk and overlapping generations
Journal Article: Asset Pricing with Idiosyncratic Risk and Overlapping Generations (2007)
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