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Recursive utility and the equity premium puzzle: A discrete-time approach

Author

Listed:
  • Aase, Knut K.

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

Abstract

We study the recursive model of Epstein and Zin. We use directional derivatives to derive the model, and calibrate to the data of Mehra and Prescott (1985). By assuming that we can view income streams as dividends of some shadow asset, the model is valid if the market portfolio is expanded to include the new asset. Since the latter is not traded, the return to the wealth portfolio is not readily observable or estimable from available data. We demonstrate that we can get a good impression of how the model fares, by calibrating under various assumptions. As the return on the wealth portfolio decreases, the estimated impatience rate decreases to reasonable values, while the risk aversion and the EIS parameter estimates are both plausible. The results are promising for the recursive model.

Suggested Citation

  • Aase, Knut K., 2013. "Recursive utility and the equity premium puzzle: A discrete-time approach," Discussion Papers 2013/3, Norwegian School of Economics, Department of Business and Management Science, revised 25 Mar 2015.
    • Handle: RePEc:hhs:nhhfms:2013_003
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    Citations

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    Cited by:

    1. Aase, Knut K., 2014. "Recursive utility and jump-diffusions," Discussion Papers 2014/9, Norwegian School of Economics, Department of Business and Management Science.
    2. Aase, Knut K., 2015. "The equity premium in a production economy; A new perspective involving recursive utility," Discussion Papers 2015/15, Norwegian School of Economics, Department of Business and Management Science.
    3. Yan, Yu & Wang, Yiming, 2020. "Consumer Asset Pricing Model Based on Heterogeneous Consumers and the Mystery of Equity Premium," MPRA Paper 98506, University Library of Munich, Germany.

    More about this item

    Keywords

    Recursive utility; the Epstein-Zin model; utility gradients; calibrations;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • 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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