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Risk Premia and Term Premia in General Equilibrium

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  • Andrew B. Abel

Abstract

The equity premium consists of a term premium reflecting the longer maturity of equity relative to short-term bills, and a risk premium reflecting the stochastic nature of equity payoffs and the deterministic nature of payoffs on reckless bills. This paper analyzes term premia and the risk premia in a general equilibrium model with catching up with the Joneses preferences and a novel formulation of leverage. Closed-form solutions for moments of asset returns are derived. First-order approximations illustrate the effects of parameters and provide an algorithm to match the means and variances of the riskless rate and the rate of return on equity.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6683.

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Date of creation: Aug 1998
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Publication status: published as Journal of Monetary Economics, Vol. 43, no. 1 (February 1999): 3-33.
Handle: RePEc:nbr:nberwo:6683

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  1. Andrew B. Abel, . "Exact Solutions for Expected Rates of Return Under Markov Regime Switching: Implications for the Equity Premium Puzzle," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 9-92, Wharton School Rodney L. White Center for Financial Research.
  2. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  3. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1995. "Asset pricing lessons for modeling business cycles," Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago 95-11, Federal Reserve Bank of Chicago.
  4. Kandel, Shmuel & Stambaugh, Robert F, 1990. "Expectations and Volatility of Consumption and Asset Returns," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 3(2), pages 207-32.
  5. Fernando Restoy & Philippe Weil, 1995. "Approximate Equilibrium Asset Prices," Banco de Espa�a Working Papers 9515, Banco de Espa�a.
  6. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers, Wharton School - Weiss Center for International Financial Research 1-90, Wharton School - Weiss Center for International Financial Research.
  7. Christopher D Carroll & Jody Overland & David N Weil, 1997. "Comparison Utility in a Growth Model," Economics Working Paper Archive, The Johns Hopkins University,Department of Economics 387, The Johns Hopkins University,Department of Economics.
  8. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  9. Backus, David K. & Gregory, Allan W. & Zin, Stanley E., 1989. "Risk premiums in the term structure : Evidence from artificial economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 24(3), pages 371-399, November.
  10. Lettau, M. & Uhlig, H., 1995. "Can Habit Formation be Reconciled with Business Cycle Facts?," Discussion Paper, Tilburg University, Center for Economic Research 1995-54, Tilburg University, Center for Economic Research.
  11. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 15(2), pages 145-161, March.
  12. Kocherlakota, Narayana R., 1990. "On the 'discount' factor in growth economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 25(1), pages 43-47, January.
  13. Campbell, John, 1993. "Intertemporal Asset Pricing Without Consumption Data," Scholarly Articles 3221491, Harvard University Department of Economics.
  14. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1429-45, November.
  15. Campbell, John, 1986. "Bond and Stock Returns in a Simple Exchange Model," Scholarly Articles 3122544, Harvard University Department of Economics.
  16. Cecchetti, Stephen G & Lam, Pok-sang & Mark, Nelson C, 1990. "Mean Reversion in Equilibrium Asset Prices," American Economic Review, American Economic Association, American Economic Association, vol. 80(3), pages 398-418, June.
  17. Gali, J., 1992. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice and Asset Prices," Papers 92-22, Columbia - Graduate School of Business.
  18. repec:fth:baesse:9515 is not listed on IDEAS
  19. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 41(2), pages 257-275, April.
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