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Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good To Be True?

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  • Stephen G. Cecchetti
  • Pok-sang Lam
  • Nelson C. Mark

Abstract

We study a Lucas asset pricing model that is standard in all respects representative agent's subjective beliefs about endowment growth are distorted. Using constant-relative-risk-aversion (CRRA) utility a CRRA coefficient below ten that exhibit, on average, excessive pessimism over expansions and excessive optimism over" contractions, our model is able to match the first and second moments of the equity premium and" risk-free rate, as well as the persistence and predictability of excess returns found in the data."

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6354.

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Date of creation: Jan 1998
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Publication status: published as Cecchetti, Stephen G., Pok-sang Lam and Nelson C. Mark. "Asset Pricing With Distorted Beliefs: Are Equity Returns To Good To Be True?," American Economic Review, 2000, v90(4,Sep), 787-805.
Handle: RePEc:nbr:nberwo:6354

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  2. Epstein, Larry G. & Zin, Stanley E., 1990. "'First-order' risk aversion and the equity premium puzzle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 26(3), pages 387-407, December.
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  8. Cochrane, John H, 1989. "The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives," American Economic Review, American Economic Association, vol. 79(3), pages 319-37, June.
  9. Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Clark, 1991. "The Equity Premium and the Risk Free Rate: Matching the Moments," NBER Working Papers 3752, National Bureau of Economic Research, Inc.
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  23. Cecchetti, Stephen G & Lam, Pok-sang & Mark, Nelson C, 1990. "Mean Reversion in Equilibrium Asset Prices," American Economic Review, American Economic Association, vol. 80(3), pages 398-418, June.
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