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Asset Prices in a Lifecycle Economy

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  • Farmer, Roger E A

Abstract

The representative agent model (RA) has dominated macroeconomics for the last thirty years. This model does a reasonably good job of explaining the co-movements of consumption, investment, GDP and employment during normal times. But it cannot easily explain movements in asset prices. Two facts are hard to understand 1) The return to equity is highly volatile and 2) The premium for holding equity, over a safe government bond, is large. The equity premium has two parts; a risk premium and a term premium. This paper constructs a lifecycle model in which agents of different generations have different savings rates and I use this model to account for a high term premium and a volatile stochastic discount factor. The fact the term premium is large, accounts for a substantial part of the observed equity premium.

Suggested Citation

  • Farmer, Roger E A, 2014. "Asset Prices in a Lifecycle Economy," CEPR Discussion Papers 9897, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:9897
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    References listed on IDEAS

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    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
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    8. Roger E.A. Farmer & Carine Nourry & Alain Venditti, 2012. "The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World," NBER Working Papers 18647, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Roger E.A. Farmer, 2016. "Pricing Assets in an Economy with Two Types of People," NBER Working Papers 22228, National Bureau of Economic Research, Inc.
    2. Byrne, Joseph P. & Cao, Shuo & Korobilis, Dimitris, 2015. "Co-Movement, Spillovers and Excess Returns in Global Bond Markets," SIRE Discussion Papers 2015-75, Scottish Institute for Research in Economics (SIRE).
    3. Byrne, Joseph P. & Cao, Shuo & Korobilis, Dimitris, 2015. "Co-Movement, Spillovers and Excess Returns in Global Bond Markets," 2007 Annual Meeting, July 29-August 1, 2007, Portland, Oregon TN 2015-75, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).

    More about this item

    Keywords

    asset prices; equity premium puzzle; excess volatility puzzle;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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