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Efficient 'myopic' asset pricing in general equilibrium : A potential pitfall in excess volatility tests

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  • Buiter, Willem H.

Abstract

Excess volatility tests for financial market efficiency maintain the hypothesis of risk-neutrality. This permits the specification of the benchmark efficient market price as the present discounted value of expected future dividends. By departing from the risk-neutrality assumption in a stripped-down version of Lucas's general equilibrium asset pricing model, I show that asset prices determined in a competitive asset market and efficient by construction can nevertheless violate the variance bounds established under the assumption of risk neutrality. This can occur even without the problems of non-stationarity (including bubbles) and finite samples. Standard excess volatility tests are joint tests of market efficiency and risk neutrality. Failure of an asset price to pass the test may be due to the absence of risk neutrality rather than to market inefficiency.
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  • Buiter, Willem H., 1987. "Efficient 'myopic' asset pricing in general equilibrium : A potential pitfall in excess volatility tests," Economics Letters, Elsevier, vol. 25(2), pages 143-148.
    • Handle: RePEc:eee:ecolet:v:25:y:1987:i:2:p:143-148
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    Cited by:

    1. Robert J. Shiller, 2014. "Speculative Asset Prices (Nobel Prize Lecture)," Cowles Foundation Discussion Papers 1936, Cowles Foundation for Research in Economics, Yale University.
    2. Robert J. Shiller, 2014. "Speculative Asset Prices," American Economic Review, American Economic Association, vol. 104(6), pages 1486-1517, June.
    3. Laimutė Urbšienė & Andrius Bugajevas & Marekas Pipiras, 2016. "The Impact Of Investment Horizon On The Return And Risk Of Investments In Securities In Lithuania," Organizations and Markets in Emerging Economies, Faculty of Economics, Vilnius University, vol. 7(2).
    4. Enrique Sentana, 1993. "The econometrics of the stock market I: rationality tests," Investigaciones Economicas, Fundación SEPI, vol. 17(3), pages 401-420, September.

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