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A Jump/Diffusion Consumption-Based Capital Asset Pricing Model and the Equity Premium Puzzle

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  • Knut K. Aase

Abstract

This paper derives the equilibrium excess returns on risky assets in an exchange economy where the underlying exogenous uncertainty is a combination of a pure multidimensional jump process and a diffusion model. We derive closed-form solutions for the interest rate and the risk premiums on risky assets for a traditional class of separable utility indices. Our analysis demonstrates that when the underlying jumps of the aggregate consumption process are not negligible, then the traditional form of the consumption-based capital asset princing model need not hold and the asset risk premiums may be larger than predicted by the traditional CCAPM in continuous time, based on pure It� diffusion processes. Our analysis suggests an explanation for the large estimates of the risk premiums reported in empirical tests of the single-beta CCAPM. Copyright 1993 Blackwell Publishers.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Mathematical Finance.

Volume (Year): 3 (1993)
Issue (Month): 2 ()
Pages: 65-84

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Handle: RePEc:bla:mathfi:v:3:y:1993:i:2:p:65-84

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Cited by:
  1. Dieckmann, Stephan & Gallmeyer, Michael, 2005. "The equilibrium allocation of diffusive and jump risks with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 29(9), pages 1547-1576, September.
  2. Eric Benhamou, 2002. "Option pricing with Levy Process," Finance 0212006, EconWPA.
  3. Eric Benhamou & Alexandre Duguet, 2000. "A 2 Dimensional Pde For Discrete Asian Options," Computing in Economics and Finance 2000 33, Society for Computational Economics.
  4. J. David Cummins & Christopher M. Lewis & Richard D. Phillips, 1998. "Pricing Excess-of-loss Reinsurance Contracts Against Catastrophic Loss," Center for Financial Institutions Working Papers 98-09, Wharton School Center for Financial Institutions, University of Pennsylvania.
  5. Aase, Knut K., 2004. "Jump Dynamics: The Equity Premium and the Risk-Free Rate Puzzles," Discussion Papers 2004/12, Department of Business and Management Science, Norwegian School of Economics.
  6. Aase, Knut K., 2000. "An equilibrium asset pricing model based on Lévy processes: relations to stochastic volatility, and the survival hypothesis," Insurance: Mathematics and Economics, Elsevier, vol. 27(3), pages 345-363, December.

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