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Inspecting The Mechanism: Closed-Form Solutions For Asset Prices In Real Business Cycle Models

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  • Martin Lettau

Abstract

We derive closed-form solutions for asset prices in an RBC economy. The equations are based on a log-linear solution of the RBC model and allow a clearer understanding of the determination of risk premia in models with production. We demonstrate not only why the premium of equity over the risk-free rate is small but also why the premium of equity over a real long-term bond is small and often negative. In particular, risk premia for equity and long real bonds are negative when technology shocks are permanent. Copyright 2003 Royal Economic Society.

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  • Martin Lettau, 2003. "Inspecting The Mechanism: Closed-Form Solutions For Asset Prices In Real Business Cycle Models," Economic Journal, Royal Economic Society, vol. 113(489), pages 550-575, July.
    • Handle: RePEc:ecj:econjl:v:113:y:2003:i:489:p:550-575
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