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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26042
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| Title: | Asset Pricing in a Production Economy with Chew-Dekel Preferences |
| Authors: | Clementi, Gian Luca
Campanale, Claudio
Castro, Rui |
| Keywords: | Equity Premium
Business Cycle
Predictability
Disappointment |
| Issue Date: | 14-May-2008 |
| Series/Report no.: | EC-07-13 |
| 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 parameter values
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 price–dividend ratio 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. Given the work of Rabin
(2000) among others, it is not surprising that our Epstein–Zin
agent exhibits a much higher risk aversion when faced with substantially
larger risks. This shortcoming, however, does not extend to the case in
which agents are disappointment averse in the sense of Gul (1991). When
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! |
| URI: | http://hdl.handle.net/2451/26042 |
| Appears in Collections: | Economics Working Papers
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