This paper derives simple closed-form solutions for expected rates of return on stocks and riskless one-period bills under the assumption that shocks to the growth rates of consumption and dividends are generated by a Markov regime-switching process. These closed-form solutions are used to show that the Markov regime-switching process exacerbates the equity premium puzzle and the risk-free rate puzzle. Three empirical examples illustrate the magnitude of the effects of Markov regime switching on equilibrium expected returns.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
4110.
Length: Date of creation: Jun 1992 Date of revision: Handle: RePEc:nbr:nberwo:4110
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