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Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good To Be True?

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  • Stephen G. Cecchetti
  • Pok-sang Lam
  • Nelson C. Mark

Abstract

We study a Lucas asset pricing model that is standard in all respects representative agent's subjective beliefs about endowment growth are distorted. Using constant-relative-risk-aversion (CRRA) utility a CRRA coefficient below ten that exhibit, on average, excessive pessimism over expansions and excessive optimism over" contractions, our model is able to match the first and second moments of the equity premium and" risk-free rate, as well as the persistence and predictability of excess returns found in the data."

Suggested Citation

  • Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1998. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good To Be True?," NBER Working Papers 6354, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6354
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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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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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