Asset pricing with idiosyncratic risk and overlapping generations

Kjetil Storesletten, Chris Telmer () and Amir Yaron

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: A number of existing studies have concluded that risk sharing allocations supported by competitive, incomplete markets equilibria are quantitatively close to first-best. Equilibrium asset prices in these models have been difficult to distinguish from those associated with a complete markets model, the counterfactual features of which have been widely documented. This paper asks if life cycle considerations, in conjunction with persistent idiosyncratic shocks which become more volatile during aggregate downturns, can reconcile the quantitative properties of the competitive asset pricing framework with those of observed asset returns. We begin by arguing that data from the Panel Study on Income Dynamics support the plausibility of such a shock process. Our estimates suggest a high degree of persistence as well as a substantial increase in idiosyncratic conditional volatility coincident with periods of low growth in U.S. GNP. When these factors are incorporated in a stationary overlapping generations framework, the implications for the returns on risky assets are substantial. Plausible parameterizations of our economy are able to generate Sharpe ratios which match those observed in U.S. data. Our economy cannot, however, account for the level of variability of stock returns, owing in large part to the specification of its production technology.

Keywords: Finance; OLG (search for similar items in EconPapers)
JEL-codes: E44 G12 (search for similar items in EconPapers)
Date: 1996-06, Revised 1999-07
New Economics Papers: this item is included in nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (63)

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Related works:
Journal Article: Asset Pricing with Idiosyncratic Risk and Overlapping Generations (2007)
Working Paper: Asset pricing with idiosyncratic risk and overlapping generations (2002)
Working Paper: Asset Pricing with Idiosyncratic Risk and Overlapping Generations (2001)
Working Paper: Asset pricing with idiosyncratic risk and overlapping generations
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Persistent link: https://EconPapers.repec.org/RePEc:upf:upfgen:405

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