Abstract

http://ssrn.com/abstract=627067
 
 

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The Impact of Fat Tails on Equilibrium Rates of Return and Term Premia


Prasad V. Bidarkota


Florida International University (FIU) - Department of Economics

Brice V. Dupoyet


Florida International University - College of Business Administration - Finance

July 2004



Abstract:     
We investigate the impact of ignoring fat tails observed in the empirical distributions of macroeconomic time series on the equilibrium implications of the consumption-based asset-pricing model with habit formation. Fat tails in the empirical distributions of consumption growth rates are modeled as a dampened power law process that nevertheless guarantees finiteness of moments of all orders. This renders model-implied mean equilibrium rates of return and equity and term premia finite. Comparison with a benchmark Gaussian process reveals that accounting for fat tails lowers the model-implied mean risk-free rate by 20 percent, raises the mean equity premium by 80 percent and the term premium by 20 percent, bringing the model implications closer to their empirically observed counterparts.

Number of Pages in PDF File: 32

Keywords: Fat tails, term premia, risk premium, Gaussian

JEL Classification: G12, G13, E43

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Date posted: December 7, 2004  

Suggested Citation

Bidarkota, Prasad V. and Dupoyet, Brice V., The Impact of Fat Tails on Equilibrium Rates of Return and Term Premia (July 2004). Available at SSRN: http://ssrn.com/abstract=627067 or http://dx.doi.org/10.2139/ssrn.627067

Contact Information

Prasad V. Bidarkota
Florida International University (FIU) - Department of Economics ( email )
University Park, DM 320A
Florida International University
Miami, FL 33199
United States
305-348-6362 (Phone)
305-348-1524 (Fax)
HOME PAGE: http://www.fiu.edu/~bidarkot/
Brice Dupoyet (Contact Author)
Florida International University - College of Business Administration - Finance ( email )
University Park, RB 209 A
11200 SW 8th Street
Miami, FL 33199
United States
305-348-3328 (Phone)
305-348-4245 (Fax)
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