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

Cecchetti, Stephen G.; Lam, Pok-sang; Mark, Nelson C.

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

NBER Working Paper No. w6354

26 Pages Posted: 16 Jul 2000 Last revised: 13 Nov 2022

See all articles by Stephen G. Cecchetti

Stephen G. Cecchetti

National Bureau of Economic Research (NBER); Brandeis International Business School; Centre for Economic Policy Research (CEPR); European Systemic Risk Board

Nelson C. Mark

University of Notre Dame - Department of Economics and Econometrics; National Bureau of Economic Research (NBER)

Date Written: January 1998

Abstract

We study a Lucas asset pricing model that is standard in all respects representative agent's subjective beliefs about endowment growth are distorted. Using constant-relative-risk-aversion (CRRA) utility a CRRA coefficient below ten that exhibit, on average, excessive pessimism over expansions and excessive optimism over" contractions, 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."

Suggested Citation: Suggested Citation

Cecchetti, Stephen G. and Cecchetti, Stephen G. and Lam, Pok-sang and Mark, Nelson Chung, Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True? (January 1998). NBER Working Paper No. w6354, Available at SSRN: https://ssrn.com/abstract=226105