IDEAS home Printed from https://ideas.repec.org/a/eee/scaman/v9y1993isupplement1ps3-s28.html
   My bibliography  Save this article

Continuous trading in an exchange economy under discontinuous dynamics: A resolution of the equity premium puzzle

Author

Listed:
  • Aase, Knut K.

Abstract

This paper analyses asset prices, the term structure of the interest rate, the spot price of risk and derives the equilibrium excess returns on risky assets in an exchange economy where the underlying exogenous uncertainty is a pure multidimensional jump process. We derive closed-form solutions for the interest rate and the risk premiums on risky assets, as well as prices of derivative assets for a general class of separable utility indices and endowment processes. Our analysis demonstrates that when the underlying jumps of the aggregate consumption process are not negligible, then the traditional form of the consumption-based capital asset pricing model need not hold and the asset risk premiums may be larger than predicted by the traditional CCAPM in continuous time, based on Itô-diffusion processes. Our alternative model for the equity premiums lends itself to possible empirical testing. We also demonstrate that a more traditional consumption-based capital asset pricing type model approximately results when the jump sizes in the aggregate consumption are small. Our analysis suggests an explanation for the large estimates of the risk premiums reported in empirical tests of the single beta CCAPM. The analytical tool used is stochastic calculus for random point processes represented by random measures.

Suggested Citation

  • Aase, Knut K., 1993. "Continuous trading in an exchange economy under discontinuous dynamics: A resolution of the equity premium puzzle," Scandinavian Journal of Management, Elsevier, vol. 9(Supplemen), pages 3-28.
  • Handle: RePEc:eee:scaman:v:9:y:1993:i:supplement1:p:s3-s28
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/095652219390003B
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Aase, Knut K., 2004. "Jump Dynamics: The Equity Premium and the Risk-Free Rate Puzzles," Discussion Papers 2004/12, Norwegian School of Economics, Department of Business and Management Science.
    2. Aase, Knut K., 2015. "The equity premium in a production economy; A new perspective involving recursive utility," Discussion Papers 2015/15, Norwegian School of Economics, Department of Business and Management Science.
    3. Jose S. Penalva Zuasti, 2001. "Insurance with Frequency Trading: A Dynamic Analysis of Efficient Insurance Markets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 790-822, October.
    4. Aase, Knut K., 2000. "An equilibrium asset pricing model based on Lévy processes: relations to stochastic volatility, and the survival hypothesis," Insurance: Mathematics and Economics, Elsevier, vol. 27(3), pages 345-363, December.
    5. Aase, Knut K., 2014. "Recursive utility and jump-diffusions," Discussion Papers 2014/9, Norwegian School of Economics, Department of Business and Management Science.
    6. Aase, Knut K. & Lillestøl, Jostein, 2015. "Beyond the local mean-variance analysis in continuous time: The problem of non-normality," Discussion Papers 2015/11, Norwegian School of Economics, Department of Business and Management Science.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:scaman:v:9:y:1993:i:supplement1:p:s3-s28. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/wps/find/journaldescription.cws_home/872/description#description .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.