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General Equilibrium With Constant Relative Risk Aversion And Vasicek Interest Rates

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  • Robert Goldstein
  • Fernando Zapatero

Abstract

We consider a pure exchange economy consisting of a single risky asset whose dividend drift rate is modeled as an Omstein-Uhlenbeck process, and a representative agent with power-utility who, in equilibrium, consumes the dividend paid by the risky asset. Endogenously determined interest rates are found to be of the Vasicek (1977) type the mean and variance of the equilibrium stock price are stochastic and have mean-reverting components A closed-form solution for a standard call option is determined for the case of log-utility. Equilibrium values have interesting implications for the equity premium puzzle observed by Mehra and Prescott (1985) Copyright 1996 Blackwell Publishers.

Suggested Citation

  • Robert Goldstein & Fernando Zapatero, 1996. "General Equilibrium With Constant Relative Risk Aversion And Vasicek Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(3), pages 331-340.
  • Handle: RePEc:bla:mathfi:v:6:y:1996:i:3:p:331-340
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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1467-9965.1996.tb00120.x
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    References listed on IDEAS

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    1. Shimko, D.C., 1991. "Beyong Implied Volatility : Probability Distributions and Hedge Ratios Implied by Option Prices," Papers 91-45, Southern California - School of Business Administration.
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    Cited by:

    1. Lundtofte, Frederik, 2008. "Expected life-time utility and hedging demands in a partially observable economy," European Economic Review, Elsevier, vol. 52(6), pages 1072-1096, August.
    2. Mele, Antonio, 2004. "General Properties of Rational Stock-Market Fluctuations," Economics Series 153, Institute for Advanced Studies.
    3. Bakshi, Gurdip S. & Zhiwu, Chen, 1997. "An alternative valuation model for contingent claims," Journal of Financial Economics, Elsevier, vol. 44(1), pages 123-165, April.
    4. George W. Blazenko & Andrey D. Pavlov, 2010. "Investment Timing for New Business Ventures," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 14(3), pages 37-68, Fall.
    5. Dragon Tang & Hong Yan, 2006. "Macroeconomic Conditions, Firm Characteristics, and Credit Spreads," Journal of Financial Services Research, Springer;Western Finance Association, vol. 29(3), pages 177-210, June.
    6. Alan V. S. Douglas & Alan G. Huang & Kenneth R. Vetzal, 2016. "Cash flow volatility and corporate bond yield spreads," Review of Quantitative Finance and Accounting, Springer, vol. 46(2), pages 417-458, February.
    7. Hong Yan, 2009. "Estimation Uncertainty and the Equity Premium-super-," International Review of Finance, International Review of Finance Ltd., vol. 9(3), pages 243-268.
    8. Munk, Claus, 2015. "Financial Asset Pricing Theory," OUP Catalogue, Oxford University Press, number 9780198716457.

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