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Asset Pricing Model with Robust Control: Recourse in Pessimism to Equity Premium

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Author Info
Eric F.Y. Lam (City University of Hong Kong)
Gregory C. Chow () (Department of Economics, Princeton University)
Abstract

Calibrating the robust asset pricing model with power utility suggest the degree of robustness of 19th century US consumer-investor to be 0.00387. When constant relative risk aversion (CRRA) is 2 and subjective discount factor equals 0.99, the mean burden-compensation for reallocating a dollar from stock to bond is estimated to be 0.05090 annually. When this mean is above 0.04801, the mean-variance of intertemporal marginal rate of substitution meets the Hansen-Jagannathan (1991) type volatility bound. For CRRA of 4, 74.25% of the empirical equity premium is due to pessimism and the rest is due to excess return’s positive correlation with consumption.

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Paper provided by East Asian Bureau of Economic Research in its series Finance Working Papers with number 204.

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Length: 32 pages
Date of creation: Sep 2003
Date of revision:
Handle: RePEc:eab:financ:204

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Related research
Keywords: Asset pricing; equity premium; investor pessimism; robust control;

Find related papers by JEL classification:
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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  12. Chow, Gregory C. & Zheng, Lihui, 2002. "Equity premium and consumption sensitivity when the consumer-investor allows for unfavorable circumstances," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1417-1429, August. [Downloadable!] (restricted)
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