eppuzzle - ECON 714: MACROECONOMIC THEORY II TA: TIM LEE...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: ECON 714: MACROECONOMIC THEORY II TA: TIM LEE MARCH 28, 2010 Equity Premium Puzzle Under standard CRRA preferences with parameter , the Euler Equation for equilibrium asset pricing is 1 = E t h ( 1 + R i , t + 1 ) ( 1 + C t + 1 )- i where R i , t + 1 is the returns to the generic i th asset and C t + 1 = C t + 1 / C t- 1. Taylor Approximation Taking a 2nd order Taylor Expansion around [ 0, 0 ] inside the brackets yields 1 + R i , t + 1- C t + 1- R i , t + 1 C t + 1 + ( + 1 ) 2 ( C t + 1 ) 2 so taking expectations and approximating the EE yields, E t R i , t + 1 + E t C t + 1 + ic- ( + 1 ) 2 2 c where = subjective discount rate, 1/ - 1 c = Var t ( C t + 1 ) ic = Cov t ( R i , t + 1 , C t + 1 ) . Hence the risk-free rate is R f , t + 1 = + E t C t + 1- ( + 1 ) 2 2 c and the equity premium for asset i is E t R i , t + 1- R f , t + 1 = ic ....
View Full Document

Page1 / 3

eppuzzle - ECON 714: MACROECONOMIC THEORY II TA: TIM LEE...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online