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Equity Premium: Interaction of Belief Heterogeneity and Distribution of Wealth?

  • Filippo Taddei

Introducing heterogeneity of beliefs across different agents builds a link between wealth distribution and the equity premium. We demonstrate that an economy populated only by risk neutral agents may nonetheless display a strictly positive equity premium. We then place our notion of belief heterogeneity within the popular representative agent construct. We show that any level of belief heterogeneity in the multi agent economy can be mapped into some specific degree of risk aversion of the representative agent economy that keeps equilibrium prices constant. A fully dynamic model follows. Finally, we suggest an explanation for the recent behavior of the equity premium: a story of "heterogeneous optimism" versus "homogeneous pessimism" is presented.

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File URL: http://www.carloalberto.org/assets/working-papers/no.67.pdf
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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 67.

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Length: 32 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:cca:wpaper:67
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  1. Aiyagari, S. Rao & Gertler, Mark, 1991. "Asset returns with transactions costs and uninsured individual risk," Journal of Monetary Economics, Elsevier, vol. 27(3), pages 311-331, June.
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  3. Ravi Jagannathan & Ellen R. McGrattan & Anna Scherbina., 2000. "The declining U.S. equity premium," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 3-19.
  4. Narayana R. Kocherlakota, 1995. "The equity premium: it's still a puzzle," Discussion Paper / Institute for Empirical Macroeconomics 102, Federal Reserve Bank of Minneapolis.
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  9. Rajnish Mehra, 2003. "The Equity Premium: Why is it a Puzzle?," NBER Working Papers 9512, National Bureau of Economic Research, Inc.
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