Asset pricing in a Lucas fruit-tree economy with the best and worst in mind
AbstractThis paper studies a Lucas (1978) fruit-tree economy under the assumption that the agents are Choquet expected utility (CEU) rather than standard expected utility decision makers. More specifically, the agents' non-additive beliefs about the economy's dividend payment process are modeled as neo-additive capacities so that the agents' decision behavior emphasizes the best, respectively worst, possible economic scenarios. In contrast to existing models of Lucas-type economies with ambiguity averse agents (Epstein and Wang, 1994), which ensure dynamic consistency through heavy restrictions on admissible ambiguity attitudes, my approach gives up dynamic consistency to the effect that quite general ambiguity attitudes become admissible. As the main formal result I establish the existence of a unique stationary equilibrium price function for this CEU Lucas economy. As the main economic insight I obtain that a representative agent who is rather preoccupied with the worst case scenario gives rise to a lower risk-free rate and a higher equity premium than predicted by the original expected utility Lucas economy. This difference is the greater the more surprising the economic information is that the agent receives.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Economic Dynamics and Control.
Volume (Year): 36 (2012)
Issue (Month): 4 ()
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Web page: http://www.elsevier.com/locate/jedc
Choquet expected utility theory; Portfolio choice; Fat tails; Asset pricing puzzles; Equity premium; Risk-free rate;
Find related papers by JEL classification:
- C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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- Alexander Ludwig & Alexander Zimper, 2012.
"A decision-theoretic model of asset-price underreaction and overreaction to dividend news,"
296, Economic Research Southern Africa.
- Alexander Ludwig & Alexander Zimper, 2012. "A decision-theoretic model of asset-price underreaction and overreaction to dividend news," Working Papers 201223, University of Pretoria, Department of Economics.
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