Asset pricing puzzles in an OLG economy with generalized preference

Amadeu DaSilva and Mira Farka

European Financial Management, 2018, vol. 24, issue 3, 331-361

Abstract: We seek to explain a number of asset pricing anomalies – the equity premium puzzle, the risk‐free rate puzzle, and portfolio allocation puzzle – in a parsimonious overlapping generations (OLG) model with two key features: borrowing constraint and Epstein–Zin–Weil (1989) preference. The model goes a long way towards the resolution of these puzzles, and is able to simultaneously match asset pricing moments and individual portfolio decisions using reasonable values of parameters governing behavior. We find that the main driver of savings behavior, equity returns, and asset allocation is the relative difference between the two parameters: the level of relative risk aversion and the inverse of the elasticity of substitution.

Date: 2018
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