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Approximate Equilibrium Asset Prices

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  • Fernando Restoy
  • Philippe Weil

Abstract

Arguing that total consumer wealth is unobservable, we invert the (approximate) consumption function to reconstruct, in a world with Kreps-Porteus generalized isoelastic preferences, (i) the wealth that supports the agents' observed consumption as an optimal outcome and (ii) the rate of return on the consumers' wealth portfolio. This allows us to (approximately) price assets solely as a function of their payoffs and of consumption--in both homoskedastic or heteroskedastic environments. We compare implied equilibrium returns on the wealth portfolio to observed stock market returns and gauge whether the stock market is a good proxy for unobserved aggregate wealth. Copyright 2011, Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rof/rfq015
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Bibliographic Info

Article provided by European Finance Association in its journal Review of Finance.

Volume (Year): 15 (2011)
Issue (Month): 1 ()
Pages: 1-28

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Handle: RePEc:oup:revfin:v:15:y:2011:i:1:p:1-28

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  1. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  2. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
  3. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  4. Dreze, Jacques H. & Modigliani, Franco, 1972. "Consumption decisions under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 308-335, December.
  5. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
  6. John W. Kendrick, 1976. "The Formation and Stocks of Total Capital," NBER Books, National Bureau of Economic Research, Inc, number kend76-1, May.
  7. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  8. Kocherlakota, Narayana R, 1990. " Disentangling the Coefficient of Relative Risk Aversion from the Elasticity of Intertemporal Substitution: An Irrelevance Result," Journal of Finance, American Finance Association, vol. 45(1), pages 175-90, March.
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