Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?
Open Access
- 1 September 2000
- journal article
- Published by American Economic Association in American Economic Review
- Vol. 90 (4) , 787-805
- https://doi.org/10.1257/aer.90.4.787
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 he persistence and predictability of excess returns found in the data.Keywords
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