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Approximate Equilibrium Asset Prices

  • Fernando Restoy
  • Philippe Weil

Arguing that total consumer wealth is unobservable, we invert the (approximate) consumption function to reconstruct, in a world with Kreps-Porteus generalized isoelastic preferences, (i) the wealth that supports the agents' observed consumption as an optimal outcome and (ii) the rate of return on the consumers' wealth portfolio. This allows us to (approximately) price assets solely as a function of their payoffs and of consumption--in both homoskedastic or heteroskedastic environments. We compare implied equilibrium returns on the wealth portfolio to observed stock market returns and gauge whether the stock market is a good proxy for unobserved aggregate wealth. Copyright 2011, Oxford University Press.

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Article provided by European Finance Association in its journal Review of Finance.

Volume (Year): 15 (2011)
Issue (Month): 1 ()
Pages: 1-28

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Handle: RePEc:oup:revfin:v:15:y:2011:i:1:p:1-28
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  1. DREZE, Jacques H. & MODIGLIANI, Franco, . "Cosumption decisions under uncertainty," CORE Discussion Papers RP 119, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
  3. John Y. Campbell, 1993. "Understanding Risk and Return," NBER Working Papers 4554, National Bureau of Economic Research, Inc.
  4. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  5. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  6. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
  7. Kocherlakota, Narayana R, 1990. " Disentangling the Coefficient of Relative Risk Aversion from the Elasticity of Intertemporal Substitution: An Irrelevance Result," Journal of Finance, American Finance Association, vol. 45(1), pages 175-90, March.
  8. John W. Kendrick, 1976. "The Formation and Stocks of Total Capital," NBER Books, National Bureau of Economic Research, Inc, number kend76-1, December.
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