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Jump Dynamics: The Equity Premium and the Risk-Free Rate Puzzles

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  • Aase, Knut K.

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

Abstract

The paper develops a consumption based equilibrium model, focusing on the risk premium and the risk-free interest rate. We derive testable expressions for these quantities, and confront these with sample estimates for the 20. century. Our framework is a dynamic model in continuous time, allowing for random jumps at random time points, in addition to diffusion uncertainty. Preferences are time separable and additive. The classical equity premium puzzle and the risk-free rate puzzle are re-examined. We present values for the parameters of the representative agent's utility function for different values of risk premia and interest rates, calibrated to two first moments of the US-data of the last century. Relatively low values for agents' risk aversion are consistent with the model, but positive values of the subjective interest rate seem harder to fit.

Suggested Citation

  • Aase, Knut K., 2004. "Jump Dynamics: The Equity Premium and the Risk-Free Rate Puzzles," Discussion Papers 2004/12, Norwegian School of Economics, Department of Business and Management Science.
    • Handle: RePEc:hhs:nhhfms:2004_012
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    File URL: http://hdl.handle.net/11250/164036
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    References listed on IDEAS

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    Cited by:

    1. Aase, Knut K, 2005. "Using Option Pricing Theory to Infer About Historical Equity Premiums," University of California at Los Angeles, Anderson Graduate School of Management qt3dd602j5, Anderson Graduate School of Management, UCLA.
    2. Aase, Knut K., 2005. "The perpetual American put option for jump-diffusions with applications," Discussion Papers 2005/12, Norwegian School of Economics, Department of Business and Management Science.
    3. Aase, Knut K., 2004. "The perpetual American put option for jump-diffusions: Implications for equity premiums," Discussion Papers 2004/19, Norwegian School of Economics, Department of Business and Management Science.

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    More about this item

    Keywords

    Consumption based CAPM; Equilibrium interest rate; The equity premium puzzle; The risk-free rate puzzle; jump/diffusions;
    All these keywords.

    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models

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