A Fact of Life: Predictable Returns from an Equilibrium Model with Simple Fundamentals
68 Pages Posted: 12 Sep 2002
Date Written: July 2002
Abstract
We show that even when "fundamentals" are i.i.d., a three-period OLG competitive model produces negatively autocorrelated expected returns, market risk premia, and prices. This negative autocorrelation arises out of market interactions between consumers that are ex-ante identical but differ by age. Conventional benchmark models do not exhibit any autocorrelation in such an i.i.d. world. The negative autocorrelation is pervasive in the model, and it remains regardless of the correlation structure of the "fundamentals". The generally agreed-upon properties of efficient markets depend heavily on conclusions from infinitely-lived representative consumer models. But these conclusions do not generalize to more complex trading environments.
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