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Approximate CAPM when preferences are CRRA

  • Herings, P.J.J.

    (General Economics 1 (Micro))

  • Kubler, F.

    (Externe publicaties SBE)

In general equilibrium models of financial markets, the capital asset pricing formula does not hold when agents have von Neumann–Morgenstern utility with constant relative risk aversion. In this paper we examine under which conditions on endowments and dividends the pricing formula provides a good benchmark for equilibrium returns. While it is easy to construct examples where equilibrium returns are arbitrarily far from those predicted by CAPM, we show that there is a large class of economies where CAPM provides a very good approximation. Although the pricing formula does not hold exactly for the chosen specification, it turns out that pricing-errors are extremely small. Copyright Springer Science+Business Media, LLC 2007

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Paper provided by Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR) in its series Research Memorandum with number 040.

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Date of creation: 01 Jan 2003
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Handle: RePEc:unm:umamet:2003040
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  1. Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
  2. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
  3. Herings P. Jean-Jacques & Kubler Felix, 2000. "Computing Equilibria in Finance Economies," Research Memorandum 010, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
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  8. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
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  12. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
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