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What Puzzles? New insights in asset pricing

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  • Aase, Knut K.

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

Abstract

Motivated by the problems of the conventional model in rationalizing market data, we derive the equilibrium interest rate and risk premiums using recursive utility in continuous time. In a representative-agent framework our model allows for the separation of risk aversion from the time preference. We demonstrate how this separation gives new insights in asset pricing: The expressions for risk premiums combine the market-based CAPM with the consumption-based CAPM. The equilibrium real interest rate now combines characterizations of preferences and market returns. This model explains both the Equity Premium Puzzle and the Risk-Free Rate Puzzle with good margin, and give solutions consistent with early resolution of uncertainty.

Suggested Citation

  • Aase, Knut K., 2012. "What Puzzles? New insights in asset pricing," Discussion Papers 2012/13, Norwegian School of Economics, Department of Business and Management Science.
    • Handle: RePEc:hhs:nhhfms:2012_013
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    File URL: http://hdl.handle.net/11250/164208
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    References listed on IDEAS

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    More about this item

    Keywords

    The equity premium puzzle; the risk-free rate puzzle; recursive utility; early resolution; utility gradients; dynamic programming; The Stern Review;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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