Template-Type: ReDIF-Paper 1.0
Author-Name: Tim W. Cogley
Author-Name-First: Tim W.
Author-Name-Last: Cogley
Author-Name: Thomas J. Sargent
Author-Name-First: Thomas J.
Author-Name-Last: Sargent
Author-Workplace-Name: Department of Economics, University of California Davis
Title: The Market Price of Risk and the Equity Premium
Abstract: Friedman and Schwartz hypothesized that the Great Depression created ex-aggerated fears of economic instability. We quantify their idea by using arobustness calculation to shatter a representative consumer?s initial confidencein the parameters of a two-state Markov chain that truly governs consump-tion growth. The assumption that the consumption data come from the trueMarkov chain and the consumer?s use of Bayes? law cause that initial pessimismto wear off. But so long as it persists, the representative consumer?s pessimismcontributes a volatile multiplicative component to the stochastic discount factorthat would be measured by a rational expectation econometrician. We studyhow this component affects asset prices. We find settings of our parametersthat make pessimism wear off slowly enough to allow our model to generatesubstantial values for the market price of risk and the equity premium.
Length: 32
File-URL: https://repec.dss.ucdavis.edu/files/wQEDcgwVUudBkKzbTocKQE95/05-22.pdf
File-Format: application/pdf
Number: 55
Classification-JEL: G12, D83, D84
KeyWords: market, risk, equity premium, asset pricing
Creation-Date: 20050228
Handle: RePEc:cda:wpaper:55