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Asset Pricing in a General Equilibrium Production Economy with Chew-Dekel Risk Preferences

Author

Listed:
  • Claudio Campanale

    () (Universidad de Alicante)

  • Gian Luca Clementi

    () (New York University)

  • Rui Castro

    () (Université de Montréal)

Abstract

In this paper we provide a thorough characterization of the asset returns implied by a simple general equilibrium production economy with convex investment adjustment costs. When households have Epstein-Zin preferences, there exist plausible parametervalues such that the model generates unconditional mean risk--free rate and equity return, and volatility of consumption growth, which are in line with historical averages for the US economy. Consistently with the data, the model's implied price--dividendratio is pro-cyclical and stock returns are predictable (and increasingly so as the time horizon increases), while dividend growth is not. The model also implies realistic values for (i) the correlation of the risk--free rate with output growth and consumption growth and (ii) the correlation pattern between risk--free rate, equity return, and equity premium. The risk implied by the model is rather low. At the modal state of nature, an individual that expects to consume for 100,000 dollars a year faces a lottery over future consumption with a standard deviation of 55 dollars (per quarter). Her risk aversion is such that she's willing to pay 1 dollar (per quarter) in order to avoid that lottery. Very similar results can be obtained assuming that agents are disappointment averse in the sense of Gul (1991). With such risk preferences, the universality requirement is not a problem to the extent that it is in the case of expected utility. In fact, faced with a lottery that has a coefficient of variation 100 times as large as that implied by our model, a disappointment averse agent displays the same relative risk aversion as an expected utility agent with logarithmic utility!

Suggested Citation

  • Claudio Campanale & Gian Luca Clementi & Rui Castro, 2008. "Asset Pricing in a General Equilibrium Production Economy with Chew-Dekel Risk Preferences," Working Papers. Serie AD 2008-14, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  • Handle: RePEc:ivi:wpasad:2008-14
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    References listed on IDEAS

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    Cited by:

    1. François Gourio, 2013. "Credit Risk and Disaster Risk," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 1-34, July.
    2. Francois Gourio, 2012. "Disaster Risk and Business Cycles," American Economic Review, American Economic Association, vol. 102(6), pages 2734-2766, October.
    3. Thien Nguyen & Steve Raymond & Lukas Schmid & Mariano Croce, 2016. "Government Debt and the Returns to Innovation," 2016 Meeting Papers 1443, Society for Economic Dynamics.
    4. Xiaohong Chen & Jack Favilukis & Sydney C. Ludvigson, 2013. "An estimation of economic models with recursive preferences," Quantitative Economics, Econometric Society, vol. 4(1), pages 39-83, March.
    5. Claudio Campanale, 2009. "Learning, Ambiguity and Life-Cycle Portfolio Allocation," 2009 Meeting Papers 38, Society for Economic Dynamics.
    6. Ralph S.J. Koijen & Jules H. van Binsbergen & Juan F. Rubio-Ramírez & Jesus Fernandez-Villaverde, 2008. "Likelihood Estimation of DSGE Models with Epstein-Zin Preferences," 2008 Meeting Papers 1099, Society for Economic Dynamics.

    More about this item

    Keywords

    Equity Premium; Business Cycle; Predictability; Disappointment Aversion.;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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