Approximate Equilibrium Asset Prices

28 Pages Posted: 14 Jul 2000 Last revised: 10 Oct 2010

See all articles by Fernando Restoy

Fernando Restoy

Banco de España

Philippe Weil

Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: June 1998

Abstract

This paper reconsiders the determination of asset returns in a model with Kreps-Porteus generalized isoelastic preferences where returns appear governed on the basis of Euler equations, by a combination of the two most common measures of risk -- covariance with the market return and covariance with consumption. To go beyond Euler equations and to take into account the links that the consumers' optimal behavior establishes, through a budge connstraint, between market returns and consumption, we derive an approximate consumption function (obtained, as in Campbell (1994), by log-linear approximation). Arguing that total consumer wealth is unobservable, we use this consumption function to reconstruct from observed consumption data i) the wealth that supports the agents' consumption optimal income, and ii) the rate of retun on the consumers' wealth portfolio. This procedure enables us to derive formulas that (approximately) price, in the tradition of Lucas (1978), all assets as a function of their payoffs and of consumption. The generalized consumption CAPM that we obtain is derived for both homoskedastic and heteroskedastic consumption processes. We also use our approximate pricing kernel to highlight the crucial role of temporal risk aversion in the determination of the equilibrium term structure of real interest rates.

Suggested Citation

Restoy, Fernando and Weil, Philippe, Approximate Equilibrium Asset Prices (June 1998). NBER Working Paper No. w6611. Available at SSRN: https://ssrn.com/abstract=226333

Fernando Restoy (Contact Author)

Banco de España ( email )

Madrid 28014
Spain
(34 91) 338 5119 (Phone)
(34 91) 338 5678 (Fax)

Philippe Weil

Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES) ( email )

Ave. Franklin D Roosevelt, 50 - C.P. 114
Brussels, B-1050
Belgium
+32 2 650 4220 (Phone)
+32 2 650 4475 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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