Asset Pricing with Non-Geometric Type of Dividends

Annals of Financial Economics, Vol. 10, No. 2, 2015

42 Pages Posted: 28 Oct 2014 Last revised: 11 Feb 2016

Akira Yamazaki

Hosei University - Graduate School of Business Administration

Date Written: April 30, 2015

Abstract

This paper examines the behavior of the market equilibrium in an endowment economy in continuous time, in which a representative investor with exponential utility consumes the dividends generated by multiple risky assets. The dividends are assumed to be mutually independent and belong to a class of non-negative stochastic processes including square root processes, increasing Levy processes, and non-Gaussian OU processes. We then characterize expected returns and volatilities on the assets as well as interest rates. Based on these quantities, we construct the CAPM in an infinitesimal time period and investigate the impacts of dividend fluctuations and the risk aversion of the investor to the market equilibrium. It is shown that even if the dividends are independent, the asset returns may have strong positive correlations. Moreover, heterogeneous dividend processes generate Jensen's alpha that can be interpreted as the small cap premium.

Keywords: Lucas model, exponential utility, asset pricing, interest rate, Sharpe ratio, return correlation, Jensen's alpha, small cap premium

JEL Classification: G12, E43, D51

Suggested Citation

Yamazaki, Akira, Asset Pricing with Non-Geometric Type of Dividends (April 30, 2015). Annals of Financial Economics, Vol. 10, No. 2, 2015. Available at SSRN: https://ssrn.com/abstract=2515220 or http://dx.doi.org/10.2139/ssrn.2515220

Akira Yamazaki (Contact Author)

Hosei University - Graduate School of Business Administration ( email )

Japan

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