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Approximate CAPM When Preferences are CRRA

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  • P. Herings

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  • Felix Kubler

Abstract

In general equilibrium models of financial markets, the capital asset pricing formula does not hold when agents have von Neumann–Morgenstern utility with constant relative risk aversion. In this paper we examine under which conditions on endowments and dividends the pricing formula provides a good benchmark for equilibrium returns. While it is easy to construct examples where equilibrium returns are arbitrarily far from those predicted by CAPM, we show that there is a large class of economies where CAPM provides a very good approximation. Although the pricing formula does not hold exactly for the chosen specification, it turns out that pricing-errors are extremely small. Copyright Springer Science+Business Media, LLC 2007

Suggested Citation

  • P. Herings & Felix Kubler, 2007. "Approximate CAPM When Preferences are CRRA," Computational Economics, Springer;Society for Computational Economics, vol. 29(1), pages 13-31, February.
  • Handle: RePEc:kap:compec:v:29:y:2007:i:1:p:13-31
    DOI: 10.1007/s10614-006-9061-3
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    References listed on IDEAS

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    More about this item

    Keywords

    asset pricing; general equilibrium; incomplete markets; D52; D58; G11; G12;

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • 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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