Asset Pricing in a General Equilibrium Production Economy with Chew-Dekel Risk Preferences

Claudio Campanale (), Gian Luca Clementi and Rui Castro

Working Papers. Serie AD from Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie)

Abstract: In this paper we provide a thorough characterization of the asset returns implied by a simple general equilibrium production economy with convex investment adjustment costs. When households have Epstein-Zin preferences, there exist plausible parametervalues such that the model generates unconditional mean risk--free rate and equity return, and volatility of consumption growth, which are in line with historical averages for the US economy. Consistently with the data, the model's implied price--dividendratio is pro-cyclical and stock returns are predictable (and increasingly so as the time horizon increases), while dividend growth is not. The model also implies realistic values for (i) the correlation of the risk--free rate with output growth and consumption growth and (ii) the correlation pattern between risk--free rate, equity return, and equity premium. The risk implied by the model is rather low. At the modal state of nature, an individual that expects to consume for 100,000 dollars a year faces a lottery over future consumption with a standard deviation of 55 dollars (per quarter). Her risk aversion is such that she's willing to pay 1 dollar (per quarter) in order to avoid that lottery. Very similar results can be obtained assuming that agents are disappointment averse in the sense of Gul (1991). With such risk preferences, the universality requirement is not a problem to the extent that it is in the case of expected utility. In fact, faced with a lottery that has a coefficient of variation 100 times as large as that implied by our model, a disappointment averse agent displays the same relative risk aversion as an expected utility agent with logarithmic utility!

Keywords: Equity Premium; Business Cycle; Predictability; Disappointment Aversion. (search for similar items in EconPapers)
JEL-codes: D81 E32 E43 E44 G12 (search for similar items in EconPapers)
Pages: 3 pages
Date: 2008-10
New Economics Papers: this item is included in nep-bec, nep-dge, nep-mac and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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http://www.ivie.es/downloads/docs/wpasad/wpasad-2008-14.pdf Fisrt version / Primera version, 2008 (application/pdf)

Related works:
Working Paper: Asset Pricing in a General Equilibrium Production Economy with Chew-Dekel Risk Preferences (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:ivi:wpasad:2008-14

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