IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper

Asset Pricing Implications of Pareto Optimality with Private Information

  • Narayana R. Kocherlakota
  • Luigi Pistaferri

In this paper, we consider a dynamic economy in which the agents in the economy are privately informed about their skills, which evolve stochastically over time in an arbitrary fashion. We consider an asset pricing equilibrium in which equilibrium quantities are constrained Pareto optimal. Under the assumption that agents have constant relative risk aversion, we derive a novel asset pricing kernel for financial asset returns. The kernel equals the reciprocal of the gross growth of the γth moment of the consumption distribution, where – is the coefficient of relative risk aversion. We use data from the consumer expenditure survey (CEX) and show that the new stochastic discount factor performs better than existing stochastic discount factors at rationalizing the equity premium. However, its ability to simultaneously explain the equity premium and the expected return to the Treasury bill is about the same as existing discount factors.

(This abstract was borrowed from another version of this item.)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.econ.umn.edu/~nkocher/revision.pdf
Download Restriction: no

Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 321307000000000701.

as
in new window

Length:
Date of creation: 12 Jan 2007
Date of revision:
Handle: RePEc:cla:levrem:321307000000000701
Contact details of provider: Web page: http://www.dklevine.com/

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
  2. Sumru Altug & Robert A. Miller, 1987. "Household choices in equilibrium," Working Papers 341, Federal Reserve Bank of Minneapolis.
  3. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report 208, Federal Reserve Bank of Minneapolis.
  4. Narayana R. Kocherlakota, 2003. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Levine's Bibliography 666156000000000426, UCLA Department of Economics.
  5. Mikhail Golosov & Narayana R. Kocherlakota & Aleh Tsyvinski, 2001. "Optimal indirect and capital taxation," Staff Report 293, Federal Reserve Bank of Minneapolis.
  6. Audrey Light & Kathleen McGarry, 2003. "Why Parents Play Favorites: Explanations for Unequal Bequests," Working Papers 03-01, Ohio State University, Department of Economics.
  7. Costas Meghir & Luigi Pistaferri, 2004. "Income Variance Dynamics and Heterogeneity," Econometrica, Econometric Society, vol. 72(1), pages 1-32, 01.
  8. Christopher Phelan & Robert M Townsend, 2010. "Computing Multi-Period, Information Constrained Optima," Levine's Working Paper Archive 117, David K. Levine.
  9. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  10. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
  11. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  12. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
  13. Ligon, Ethan, 1996. "Risk-Sharing and Information: Theory and Measurement in Village Economies," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt0mx075dh, Department of Agricultural & Resource Economics, UC Berkeley.
  14. Hanno Lustig & Yi-Li Chien, 2005. "The Market Price of Aggregate Risk and the Wealth Distribution," NBER Working Papers 11132, National Bureau of Economic Research, Inc.
  15. Andrei Semenov, 2004. "High-Order Consumption Moments and Asset Pricing," Econometric Society 2004 North American Winter Meetings 130, Econometric Society.
  16. Kjetil Storesletten & Chris I. Telmer & Amir Yaron, 2001. "How Important Are Idiosyncratic Shocks? Evidence from Labor Supply," American Economic Review, American Economic Association, vol. 91(2), pages 413-417, May.
  17. Ethan Ligon, 1998. "Risk Sharing and Information in Village Economies," Review of Economic Studies, Oxford University Press, vol. 65(4), pages 847-864.
  18. Balduzzi, Pierluigi & Yao, Tong, 2007. "Testing heterogeneous-agent models: an alternative aggregation approach," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 369-412, March.
  19. Orazio P. Attanasio & Guglielmo Weber, 1994. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," NBER Working Papers 4795, National Bureau of Economic Research, Inc.
  20. Orazio Attanasio & James Banks & Sarah Tanner, 1998. "Asset holding and consumption volatility," IFS Working Papers W98/08, Institute for Fiscal Studies.
  21. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 957-76, October.
  22. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
  23. Kocherlakota, Narayana R., 1998. "The effects of moral hazard on asset prices when financial markets are complete," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 39-56, February.
  24. Orazio Attanasio & Erich Battistin & Hidehiko Ichimura, 2004. "What Really Happened to Consumption Inequality in the US?," NBER Working Papers 10338, National Bureau of Economic Research, Inc.
  25. Attanasio, Orazio & Davis, Steven J, 1996. "Relative Wage Movements and the Distribution of Consumption," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1227-62, December.
  26. Timothy Cogley, 1998. "Idiosyncratic risk and the equity premium: evidence from the Consumer Expenditure Survey," Working Papers in Applied Economic Theory 98-07, Federal Reserve Bank of San Francisco.
  27. Atkeson Andrew & Lucas Jr. , Robert E., 1995. "Efficiency and Equality in a Simple Model of Efficient Unemployment Insurance," Journal of Economic Theory, Elsevier, vol. 66(1), pages 64-88, June.
  28. Andrei Semenov, 2004. "High-Order Consumption Moments and Asset Pricing," 2004 Meeting Papers 334, Society for Economic Dynamics.
  29. Phelan, Christopher, 1994. "Incentives, insurance, and the variability of consumption and leisure," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 581-599.
  30. Phelan, J.C., 1990. "Incentives, Insurance And The Variability Of Con Somption And Leisure," Working papers 90-26, Wisconsin Madison - Social Systems.
  31. Christopher R. Bollinger & Amitabh Chandra, 2005. "Iatrogenic Specification Error: A Cautionary Tale of Cleaning Data," Journal of Labor Economics, University of Chicago Press, vol. 23(2), pages 235-258, April.
  32. Christopher Phelan & Robert M. Townsend, 1991. "Computing Multi-Period, Information-Constrained Optima," Review of Economic Studies, Oxford University Press, vol. 58(5), pages 853-881.
  33. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
  34. J. A. Mirrlees, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Oxford University Press, vol. 38(2), pages 175-208.
  35. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
  36. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing Specification Errors in Stochastic Discount Factor Models," NBER Technical Working Papers 0153, National Bureau of Economic Research, Inc.
  37. Ligon, Ethan, 2005. "Formal Markets and Informal Insurance," International Review of Law and Economics, Elsevier, vol. 25(1), pages 75-88, March.
  38. McGarry, K & Schoeni, R-F, 1996. "Measurement and the Redistribution of Resources Within the Family," Papers 96-11, RAND - Reprint Series.
  39. Kocherlakota, Narayana R., 1990. "On tests of representative consumer asset pricing models," Journal of Monetary Economics, Elsevier, vol. 26(2), pages 285-304, October.
  40. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August.
  41. Constantinides, George M & Duffie, Darrell, 1996. "Asset Pricing with Heterogeneous Consumers," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 219-40, April.
  42. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," NBER Working Papers 8896, National Bureau of Economic Research, Inc.
Full references (including those not matched with items on IDEAS)

This item is featured on the following reading lists or Wikipedia pages:

  1. Asset Pricing Implications of Pareto Optimality with Private Information (JPE 2009) in ReplicationWiki

When requesting a correction, please mention this item's handle: RePEc:cla:levrem:321307000000000701. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (David K. Levine)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.