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Valuation Risk and Asset Pricing

  • Albuquerque, Rui
  • Eichenbaum, Martin
  • Rebelo, Sérgio

Standard representative-agent models have difficulty in accounting for the weak correlation between stock returns and measurable fundamentals, such as consumption and output growth. This failing underlies virtually all modern asset-pricing puzzles. The correlation puzzle arises because these models load all uncertainty onto the supply side of the economy. We propose a simple theory of asset pricing in which demand shocks play a central role. These shocks give rise to valuation risk that allows the model to account for key asset pricing moments, such as the equity premium, the bond term premium, and the weak correlation between stock returns and fundamentals.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9262.

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Date of creation: Dec 2012
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Handle: RePEc:cpr:ceprdp:9262
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  1. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
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