DMCA
The Market Price of Risk and the Equity Premium: A Legacy of the Great Depression (2008)
Cached
Download Links
| Venue: | Journal of Monetary Economics |
| Citations: | 69 - 5 self |
BibTeX
@ARTICLE{Cogley08themarket,
author = {Timothy Cogley and Thomas J. Sargent},
title = {The Market Price of Risk and the Equity Premium: A Legacy of the Great Depression},
journal = {Journal of Monetary Economics},
year = {2008}
}
Share
 |
 |
 |
 |
||
OpenURL
Abstract
Friedman and Schwartz hypothesized that the Great Depression created exaggerated fears of economic instability. We quantify their idea by using a robustness calculation to shatter a representative consumer’s initial confidence in the parameters of a two-state Markov chain that truly governs consumption growth. The assumption that the consumption data come from the true Markov chain and the consumer’s use of Bayes ’ law cause that initial pessimism to wear off. But so long as it persists, the representative consumer’s pessimism contributes a volatile multiplicative component to the stochastic discount factor that would be measured by a rational expectation econometrician. We study how this component affects asset prices. We find settings of our parameters that make pessimism wear off slowly enough to allow our model to generate substantial values for the market price of risk and the equity premium. Key words: Robustness, learning, asset pricing. 1
Keyphrases
great depression market price equity premium bayes law cause asset price asset pricing consumption growth rational expectation consumption data two-state markov chain robustness calculation representative consumer initial confidence substantial value economic instability stochastic discount factor volatile multiplicative component exaggerated fear initial pessimism true markov chain key word representative consumer pessimism consumer use
