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Revisiting Asset Pricing Puzzles in an Exchange Economy

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  • Christine A. Parlour
  • Richard Stanton
  • Johan Walden

Abstract

We show that several well-known asset pricing puzzles are largely mitigated if we endow the representative agent with an arbitrarily small minimum consumption level. This allows us to solve the model for parameter values where the standard "Lucas tree" model is not defined. For these parameters, disasters become more important, and the market risk premium therefore higher, even though consumption is less risky. Our model yields reasonable risk premia, Sharpe ratios, and discount rates; excess price volatility; and a high market price-dividend ratio. We derive closed-form solutions for all variables of interest. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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  • Christine A. Parlour & Richard Stanton & Johan Walden, 2011. "Revisiting Asset Pricing Puzzles in an Exchange Economy," Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 629-674.
  • Handle: RePEc:oup:rfinst:v:24:y:2011:i:3:p:629-674
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    File URL: http://hdl.handle.net/10.1093/rfs/hhq130
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    Cited by:

    1. Curatola, Giuliano, 2015. "Loss aversion, habit formation and the term structures of equity and interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 53(C), pages 103-122.
    2. Hansen, Simon Lysbjerg, 2015. "Cross-sectional asset pricing with heterogeneous preferences and beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 125-151.

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