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Street-smart asset pricing

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  • Vinay Asthana

Abstract

This article looks at consumption-based asset pricing from a novel perspective that seeks to find common ground between academic research and 'street wisdom', i.e. the popularly held beliefs of the stock market participants and observers. I start with an examination of the literature to identify themes of academic research that are compatible with 'street wisdom'. Using these themes -- namely, the themes of 'fear' (the fear of rare disasters) and 'greed' (the direct preference for wealth) -- I develop a modified version of consumption-based capital asset pricing model which juxtaposes the rare disaster framework with the concept of spirit of capitalism. In essence, this is an 'academic' model which derives its inspiration from 'street wisdom' but aspires to solve 'academic' asset pricing puzzles. I succeed in arriving at analytical solutions for asset prices. For the empirical validation of this 'street-smart' asset pricing model, I assess its ability to explain the equity premium puzzle using available international historical data sets. The calibration results suggest that the 'street-smart' model is indeed smart.

Suggested Citation

  • Vinay Asthana, 2013. "Street-smart asset pricing," Applied Financial Economics, Taylor & Francis Journals, vol. 23(17), pages 1371-1381, September.
    • Handle: RePEc:taf:apfiec:v:23:y:2013:i:17:p:1371-1381
    DOI: 10.1080/09603107.2013.818209
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    References listed on IDEAS

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    1. repec:fth:harver:1421 is not listed on IDEAS
    2. Christian Julliard & Anisha Ghosh, 2012. "Can Rare Events Explain the Equity Premium Puzzle?," The Review of Financial Studies, Society for Financial Studies, vol. 25(10), pages 3037-3076.
    3. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
    4. Copeland, Laurence & Zhu, Yanhui, 2007. "Rare Disasters and the Equity Premium in a Two-Country World," Cardiff Economics Working Papers E2007/6, Cardiff University, Cardiff Business School, Economics Section.
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