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Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?

Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True? Abstract We study a Lucas asset-pricing model that is standard in all respects, except that the representative agent's subjective beliefs about endowment growth are distorted. Using constant relative risk-aversion (CRRA) utility, with a CRRA coefficient below 10; fluctuating beliefs that exhibit, on average, excessive pessimism over expansions; and excessive optimism over contractions (both ending more quickly than the data suggest), our model is able to match the first and second moments of the equity premium and risk-free rate, as well as the persistence and predictability of excess returns found in the data. (JEL E44, G12 ) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Review American Economic Association

Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?

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References (32)

Publisher
American Economic Association
Copyright
Copyright © 2000 by the American Economic Association
Subject
Articles
ISSN
0002-8282
DOI
10.1257/aer.90.4.787
Publisher site
See Article on Publisher Site

Abstract

Abstract We study a Lucas asset-pricing model that is standard in all respects, except that the representative agent's subjective beliefs about endowment growth are distorted. Using constant relative risk-aversion (CRRA) utility, with a CRRA coefficient below 10; fluctuating beliefs that exhibit, on average, excessive pessimism over expansions; and excessive optimism over contractions (both ending more quickly than the data suggest), our model is able to match the first and second moments of the equity premium and risk-free rate, as well as the persistence and predictability of excess returns found in the data. (JEL E44, G12 )

Journal

American Economic ReviewAmerican Economic Association

Published: Sep 1, 2000

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