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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. Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1988. "Mean Reversion in Equilibrium Asset Prices," NBER Working Papers 2762, National Bureau of Economic Research, Inc.
  2. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1995. "Asset pricing lessons for modeling business cycles," Working Papers 560, Federal Reserve Bank of Minneapolis.
  3. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
  4. Andrew B. Abel, 1992. "Exact Solutions for Expected Rates of Return Under Markov Regime Switching: Implications for the Equity Premium Puzzle," NBER Working Papers 4110, National Bureau of Economic Research, Inc.
  5. Christopher D Carroll & Jody Overland & David N Weil, 1997. "Comparison Utility in a Growth Model," Economics Working Paper Archive 387, The Johns Hopkins University,Department of Economics.
  6. Kocherlakota, Narayana R., 1990. "On the 'discount' factor in growth economies," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 43-47, January.
  7. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 1-90, Wharton School Rodney L. White Center for Financial Research.
  8. John Y. Campbell, 1987. "Bond and Stock Returns in a Simple Exchange Model," NBER Working Papers 1509, National Bureau of Economic Research, Inc.
  9. Fernando Restoy & Philippe Weil, 1998. "Approximate Equilibrium Asset Prices," NBER Working Papers 6611, National Bureau of Economic Research, Inc.
  10. Gali, J., 1992. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice and Asset Prices," Papers 92-22, Columbia - Graduate School of Business.
  11. Kandel, Shmuel & Stambaugh, Robert F, 1990. "Expectations and Volatility of Consumption and Asset Returns," Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 207-32.
  12. John Y. Campbell, 1992. "Intertemporal Asset Pricing Without Consumption Data," NBER Working Papers 3989, National Bureau of Economic Research, Inc.
  13. repec:fth:baesse:9515 is not listed on IDEAS
  14. John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
  15. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  16. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  17. 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, vol. 24(3), pages 371-399, November.
  18. Lettau, M. & Uhlig, H., 1995. "Can Habit Formation be Reconciled with Business Cycle Facts?," Discussion Paper 1995-54, Tilburg University, Center for Economic Research.
  19. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
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