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Revisiting Asset Pricing Puzzles in an Exchange Economy

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  • Christine A. Parlour
  • Richard Stanton
  • Johan Walden
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    Abstract

    We show that several well-known asset pricing puzzles are largely mitigated if we endow the representative agent with an arbitrarily small minimum consumption level. This allows us to solve the model for parameter values where the standard "Lucas tree" model is not defined. For these parameters, disasters become more important, and the market risk premium therefore higher, even though consumption is less risky. Our model yields reasonable risk premia, Sharpe ratios, and discount rates; excess price volatility; and a high market price-dividend ratio. We derive closed-form solutions for all variables of interest. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/rfs/hhq130
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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal Review of Financial Studies.

    Volume (Year): 24 (2011)
    Issue (Month): 3 ()
    Pages: 629-674

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    Handle: RePEc:oup:rfinst:v:24:y:2011:i:3:p:629-674

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