High equity premia and crash fears - Rational foundations

Massimo Guidolin

Economic Theory, 2006, vol. 28, issue 3, 693-708

Abstract: We show that in a Lucas endowment economy in which the process for dividends is described by a lattice tree subject to infrequent but observable structural breaks, in equilibrium recursive rational learning may inflate the equity risk premium and reduce the risk-free interest rate for low levels of risk aversion. The key condition for these results to obtain is the presence of sufficient initial pessimism. The relevance of these findings is magnified by the fact that under full information our artificial economy cannot generate asset returns matching the empirical evidence for any positive relative risk aversion. Copyright Springer-Verlag Berlin/Heidelberg 2006

Keywords: Rational learning; Equity premium; Structural breaks. (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (7)

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DOI: 10.1007/s00199-005-0639-0

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