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Asset pricing in a Lucas fruit-tree economy with the best and worst in mind

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  • Zimper, Alexander

Abstract

This paper studies a Lucas (1978) fruit-tree economy under the assumption that the agents are Choquet expected utility (CEU) rather than standard expected utility decision makers. More specifically, the agents' non-additive beliefs about the economy's dividend payment process are modeled as neo-additive capacities so that the agents' decision behavior emphasizes the best, respectively worst, possible economic scenarios. In contrast to existing models of Lucas-type economies with ambiguity averse agents (Epstein and Wang, 1994), which ensure dynamic consistency through heavy restrictions on admissible ambiguity attitudes, my approach gives up dynamic consistency to the effect that quite general ambiguity attitudes become admissible. As the main formal result I establish the existence of a unique stationary equilibrium price function for this CEU Lucas economy. As the main economic insight I obtain that a representative agent who is rather preoccupied with the worst case scenario gives rise to a lower risk-free rate and a higher equity premium than predicted by the original expected utility Lucas economy. This difference is the greater the more surprising the economic information is that the agent receives.

Suggested Citation

  • Zimper, Alexander, 2012. "Asset pricing in a Lucas fruit-tree economy with the best and worst in mind," Journal of Economic Dynamics and Control, Elsevier, vol. 36(4), pages 610-628.
  • Handle: RePEc:eee:dyncon:v:36:y:2012:i:4:p:610-628
    DOI: 10.1016/j.jedc.2011.11.006
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    Cited by:

    1. Christian A. Stoltenberg & Vadym Lepetyuk, 2012. "Reconciling consumption inequality with income inequality," Working Papers. Serie AD 2012-19, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    2. repec:mea:meawpa:13270 is not listed on IDEAS
    3. Groneck, Max & Ludwig, Alexander & Zimper, Alexander, 2013. "Ambiguous Survival Beliefs and Hyperbolic Discounting in a Life-Cycle Model," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79878, Verein für Socialpolitik / German Economic Association.
    4. Alexander Ludwig & Alexander Zimper, 2013. "A decision-theoretic model of asset-price underreaction and overreaction to dividend news," Annals of Finance, Springer, vol. 9(4), pages 625-665, November.
    5. Groneck, Max & Ludwig, Alexander & Zimper, Alexander, 2016. "A life-cycle model with ambiguous survival beliefs," Journal of Economic Theory, Elsevier, vol. 162(C), pages 137-180.
    6. Craig Webb, 2015. "Piecewise additivity for non-expected utility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 60(2), pages 371-392, October.
    7. Vadym Lepetyuk & Christian A. Stoltenberg, 2013. "Reconciling Consumption Inequality with Income Inequality," Tinbergen Institute Discussion Papers 13-124/VI, Tinbergen Institute.
    8. Ludwig, Alexander & Zimper, Alexander, 2014. "Biased Bayesian learning with an application to the risk-free rate puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 39(C), pages 79-97.
    9. Beißner, Patrick & Lin, Qian & Riedel, Frank, 2016. "Dynamically consistent α-Maxmin expected utility," Center for Mathematical Economics Working Papers 535, Center for Mathematical Economics, Bielefeld University.
    10. repec:kap:theord:v:82:y:2017:i:3:d:10.1007_s11238-016-9569-5 is not listed on IDEAS

    More about this item

    Keywords

    Choquet expected utility theory; Portfolio choice; Fat tails; Asset pricing puzzles; Equity premium; Risk-free rate;

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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