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Asset Pricing with Idiosyncratic Risk and Overlapping Generations
Stockholm University, Faculty of Social Sciences, Institute for International Economic Studies.
Graduate School of Industrial Administration, Carnegie Mellon University.
Wharton School, University of Pennsylvania.
2002 (English)Report (Other academic)
Abstract [en]

Constantinides and Duffie (1996) show that for idiosyncratic risk to matter for asset pricing the shocks must (i) be highly persistent and (ii) become more volatile during economic contractions. We show that data from the Panel Study on Income Dynamics (PSID) are consistent with these requirements. Our results are based on econometric methods which incorporate macroeconomic information going beyond the time horizon of the PSID, dating back to 1910. We go on to argue that life-cycle effects are fundamental for how idiosyncratic risk affects asset pricing. We use a stationary overlapping-generations model to show that life-cycle effects can either mitigate or accentuate the equity premium, the critical ingredient being whether agents accumulate or deccumulate riskt assets as they age. Our model predicts the latter and is able to account for both the average equity premium and the Sharpe ratio observed on the U.S. stock market.

Place, publisher, year, edition, pages
Stockholm: IIES , 2002. , 56 p.
Seminar Paper / Institute for International Economic Studies, Stockholm University. (Online), ISSN 1653-610X
National Category
URN: urn:nbn:se:su:diva-41188OAI: diva2:328962
Available from: 2010-07-07 Created: 2010-07-07 Last updated: 2016-04-08Bibliographically approved

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