Abel (2002) shows that pessimism and doubt in the subjective distribution of the growth rate of consumption reduce the riskfree rate puzzle and the equity premium puzzle. We quantify the amount of pessimism and doubt in survey data on US consumption and income. Individual forecasters are in fact pessimistic, but show marked overconfidence rather than doubt. Whether this implies that overconfidence should be built into Abel's model depends on how the empirically heterogeneous subjective distributions are mapped into the distribution of a fictitious representative agent. We work out the form of this mapping in an Arrow-Debreu economy and show that the equity premium increases with the dispersion of beliefs. We then estimate this aggregate distribution and find little evidence of either overconfidence or doubt.
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Paper provided by Institute for Financial Research in its series SIFR Research Report Series with number
19.
Length: 20 pages Date of creation: 15 Aug 2003 Date of revision: Handle: RePEc:hhs:sifrwp:0019
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Christoffersen, Peter F, 1998.
"Evaluating Interval Forecasts,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 841-62, November.
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