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A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity? Author info | Abstract | Publisher info | Download info | Related research | Statistics M. Fatih Guvenen () (University of Rochester )
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In this paper we study the asset pricing implications of a parsimonious two-agent macroeconomic model with two key features: limited participation in the stock market and heterogeneity in the elasticity of intertemporal substitution. The parameter values for the model are taken from the real business cycle literature and are not calibrated to match any financial statistic. Yet, with a risk aversion of two, the model is able to explain a large number of asset pricing phenomena including all the facts matched by the external habit model of Campbell and Cochrane (1999). Examples in this list include a high equity premium and a low risk-free rate; a counter-cyclical risk premium, volatility and Sharpe ratio; predictable stock returns with coe?cients and R2 values of long-horizon regressions matching their empirical counterparts, among others. In addition the model generates a risk-free rate with low volatility (5.7 percent annually) and with high persistence. We also show that the similarity of our results to those from an external habit model is not a coincidence: the model has a reduced form representation which is extremely similar to Campbell and Cochrane’s framework for asset pricing. However, the macroeconomic implications of the two models are very different, favoring the limited participation model. Moreover, we show that policy analysis yields dramatically different conclusions in each framework.
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Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number
499.
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Length: 41 pages
Date of creation: Mar 2003Date of revision:
Handle: RePEc:roc:rocher:499Contact details of provider: Postal: UNIVERSITY OF ROCHESTER, CENTER FOR ECONOMIC RESEARCH, DEPARTMENT OF ECONOMICS, HARKNESS 231 ROCHESTER NEW YORK 14627 U.S.A.
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Keywords: Limited stock market participation asset pricing the equity premium puzzle incomplete markets habit formation elasticity of intertemporal substitution. Other versions of this item:
Find related papers by JEL classification: E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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Fatih Guvenen, 2005.
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Macroeconomics
0507005, EconWPA.
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Other versions:
M. Fatih Guvenen, 2002.
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RCER Working Papers
491, University of Rochester - Center for Economic Research (RCER), revised Mar 2003.
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Review of Economic Dynamics, vol. 9(2), April.
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Charlotte Christiansen & Juanna Schröter Joensen & Jesper Rangvid, 2007.
"Are Economists More Likely to Hold Stocks? ,"
CREATES Research Papers
2007-08, School of Economics and Management, University of Aarhus.
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Kjetil Storesletten & Chris Telmer & Amir Yaron, 2007.
"Asset Pricing with Idiosyncratic Risk and Overlapping Generations ,"
Review of Economic Dynamics ,
Elsevier for the Society for Economic Dynamics, vol. 10(4), pages 519-548, October.
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Storesletten, Kjetil & Telmer, Chris & Yaron, Amir, 2001.
"Asset Pricing with Idiosyncratic Risk and Overlapping Generations ,"
CEPR Discussion Papers
3065, C.E.P.R. Discussion Papers.
[Downloadable!] (restricted) Kjetil Storesletten & Chris Telmer & Amir Yaron, 1996.
"Asset Pricing with Idiosyncratic Risk and Overlapping Generations ,"
Economics Working Papers
405, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 1999.
[Downloadable!] Storesletten, Kjetil & Telmer, Chris & Yaron, Amir, 2002.
"Asset pricing with idiosyncratic risk and overlapping generations ,"
Seminar Papers
703, Stockholm University, Institute for International Economic Studies.
[Downloadable!] Kjetil Storesletten & Chris Telmer & Amir Yaron, .
"Asset pricing with idiosyncratic risk and overlapping generations ,"
GSIA Working Papers
226, Carnegie Mellon University, Tepper School of Business.
[Downloadable!] Qiang Zhang, 2004.
"Accounting for Human Capital and Weak Identification in Evaluating the Esptein-Zin-Weil Non-Expected Utility Model of Asset Pricing ,"
CIRJE F-Series
CIRJE-F-289, CIRJE, Faculty of Economics, University of Tokyo.
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Gomes, Francisco J & Michaelides, Alexander, 2007.
"Asset Pricing with Limited Risk Sharing and Heterogeneous Agents ,"
CEPR Discussion Papers
6136, C.E.P.R. Discussion Papers.
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"Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model ,"
SFB 649 Discussion Papers
SFB649DP2007-003a, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
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Harald Uhlig, 2007.
"Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model ,"
SFB 649 Discussion Papers
SFB649DP2007-003, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
[Downloadable!] Harald Uhlig, 2007.
"Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model ,"
American Economic Review ,
American Economic Association, vol. 97(2), pages 239-243, May.
Luca Benzoni & Pierre Collin-Dufresne & Robert S. Goldstein, 2005.
"Portfolio Choice over the Life-Cycle in the Presence of 'Trickle Down' Labor Income ,"
NBER Working Papers
11247, National Bureau of Economic Research, Inc.
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Lungu, Laurian & Minford, Patrick, 2005.
"Explaining The Equity Risk Premium ,"
CEPR Discussion Papers
5017, C.E.P.R. Discussion Papers.
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"Do More Economists Hold Stocks? ,"
Finance Research Group Working Papers
F-2005-02, University of Aarhus, Aarhus School of Business, Department of Business Studies.
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"Exploring the Link between Housing and the Value Premium (joint with Stijn Van Nieuwerburgh) ,"
UCLA Economics Online Papers
389, UCLA Department of Economics.
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