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Consumption Asset Pricing with Stable Shocks: Exploring a Solution and Its Implications for the Equity Premium Puzzle

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  • Prasad V. Bidarkota and J. Huston McCulloch

Abstract

We study the consumption based asset pricing model due to Lucas (1978). The exogenous endowment sequence is modeled as a linear stochastic process driven by stable shocks in an otherwise standard framework. The Gaussian process emerges as a special case. We derive exact analytical solutions for asset prices and returns, and provide conditions under which these exist. We also study the implications of the model for the equity premium puzzle.

Suggested Citation

  • Prasad V. Bidarkota and J. Huston McCulloch, 2001. "Consumption Asset Pricing with Stable Shocks: Exploring a Solution and Its Implications for the Equity Premium Puzzle," Computing in Economics and Finance 2001 70, Society for Computational Economics.
  • Handle: RePEc:sce:scecf1:70
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    References listed on IDEAS

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    1. Prasad V. Bidarkota, 2000. "Asymmetries in the Conditional Mean Dynamics of Real GNP: Robust Evidence," The Review of Economics and Statistics, MIT Press, vol. 82(1), pages 153-157, February.
    2. Burnside, Craig, 1998. "Solving asset pricing models with Gaussian shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 22(3), pages 329-340, March.
    3. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Intrinsic Bubbles: The Case of Stock Prices," American Economic Review, American Economic Association, vol. 81(5), pages 1189-1214, December.
    4. Pok-sang Lam & Stephen G. Cecchetti & Nelson C. Mark, 2000. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?," American Economic Review, American Economic Association, vol. 90(4), pages 787-805, September.
    5. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    6. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-396, March.
    7. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    8. Benoit Mandelbrot, 2015. "The Variation of Certain Speculative Prices," World Scientific Book Chapters,in: THE WORLD SCIENTIFIC HANDBOOK OF FUTURES MARKETS, chapter 3, pages 39-78 World Scientific Publishing Co. Pte. Ltd..
    9. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March.
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    More about this item

    Keywords

    Asset pricing; Lucas model; equity premium; normal distributions; stable distributions;

    JEL classification:

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

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