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The equity premium puzzle and the risk-free rate puzzle

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  • Weil, Philippe

Abstract

This paper studies the implications for general equilibrium asset pricing of a recently introduced class of Kreps-Porteus non-expected utility preferences, which is characterized by a constant intertemporal elasticity of substitution and a constant, but unrelated, coefficient of relative risk aversion. It is shown that the solution to the "equity premium puzzle" documented by Mehra and Prescott [19851 cannot be found, for plausibly calibrated parameter values, by simply separating risk aversion from intertemporal substitution. Rather, relaxing the parametric restriction on tastes implicit in the time-addictive expected utility specification and adopting Kreps-Porteus preferences in the direction of "more realism" is likely to add a "riskfree rate puzzle" to Mehra's and Prescott's "equity premium puzzle."

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 24 (1989)
Issue (Month): 3 (November)
Pages: 401-421

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Handle: RePEc:eee:moneco:v:24:y:1989:i:3:p:401-421

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. Mankiw, N Gregory & Shapiro, Matthew D, 1986. "Risk and Return: Consumption Beta versus Market Beta," The Review of Economics and Statistics, MIT Press, vol. 68(3), pages 452-59, August.
  2. Sanford J. Grossman & Guy Laroque, 1987. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," NBER Working Papers 2369, National Bureau of Economic Research, Inc.
  3. Farmer, Roger, 1987. "Closed-Form Solutions to Dynamic Stochastic Choice Problems," The Warwick Economics Research Paper Series (TWERPS) 282, University of Warwick, Department of Economics.
  4. Dreze, Jacques H. & Modigliani, Franco, 1972. "Consumption decisions under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 308-335, December.
  5. David M Kreps & Evan L Porteus, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Levine's Working Paper Archive 625018000000000009, David K. Levine.
  6. Kahn, James A., 1990. "Moral hazard, imperfect risk-sharing, and the behavior of asset returns," Journal of Monetary Economics, Elsevier, vol. 26(1), pages 27-44, August.
  7. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  8. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  9. Kreps, David M & Porteus, Evan L, 1979. "Dynamic Choice Theory and Dynamic Programming," Econometrica, Econometric Society, vol. 47(1), pages 91-100, January.
  10. Larry G. Epstein & Stanley E. Zin, 1987. "Substitution, Risk Aversion and the Temporal Behaviour of Consumption and Asset Returns I: A Theoretical Framework," Working Papers 699, Queen's University, Department of Economics.
  11. Kreps, David M. & Porteus, Evan L., 1979. "Temporal von neumann-morgenstern and induced preferences," Journal of Economic Theory, Elsevier, vol. 20(1), pages 81-109, February.
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  1. About very large risk aversion estimates
    by Economic Logician in Economic Logic on 2011-08-05 14:59:00
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