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Approximate CAPM When Preferences are CRRA

  • P. Herings

    ()

  • Felix Kubler

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

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File URL: http://hdl.handle.net/10.1007/s10614-006-9061-3
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Article provided by Society for Computational Economics in its journal Computational Economics.

Volume (Year): 29 (2007)
Issue (Month): 1 (February)
Pages: 13-31

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Handle: RePEc:kap:compec:v:29:y:2007:i:1:p:13-31
Contact details of provider: Web page: http://www.springerlink.com/link.asp?id=100248

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  1. Andrew Ang & Joseph Chen & Yuhang Xing, 2005. "Downside Risk," NBER Working Papers 11824, National Bureau of Economic Research, Inc.
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  8. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  9. John Geanakoplos & Martin Shubik, 1989. "The Capital Asset Pricing Model as a General Equilibrium with Incomplete Markets," Cowles Foundation Discussion Papers 913, Cowles Foundation for Research in Economics, Yale University.
  10. Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
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