Idiosyncratic Risk and Higher-Order Cumulants
We show that, when allowing for general distributions of dividend growth in a Lucas economy with multiple "trees," idiosyncratic volatility will affect expected returns in ways that are not captured by the log linear approximation. We derive an exact expression for the risk premia for general distributions. Assuming growth rates are Normal Inverse Gaussian (NIG) and fitting the distribution to the data used in Mehra and Prescott (1985), the coefficient of relative risk aversion required to match the equity premium is more than halved compared to the finding in their article.
|Date of creation:||30 Sep 2011|
|Date of revision:|
|Contact details of provider:|| Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden|
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Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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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.:
- Ian Martin, 2010.
"Consumption-Based Asset Pricing with Higher Cumulants,"
NBER Working Papers
16153, National Bureau of Economic Research, Inc.
- Ian Martin, 2011.
"The Lucas Orchard,"
NBER Working Papers
17563, National Bureau of Economic Research, Inc.
- Mahmoud Hamada & Emiliano A. Valdez, 2008. "CAPM and Option Pricing With Elliptically Contoured Distributions," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 75(2), pages 387-409.
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