Asset Prices in Production Economies with an Endogenous Extensive Margin
22 Pages Posted: 1 May 2016
Date Written: July 31, 2015
In economies that exhibit love-for-variety either in preferences or technology, the official consumer price index differs from the welfare-based price aggregator. This wedge implies that the stochastic discount factor should be adjusted to account for changes in the range of goods. This paper shows that a real business cycle model with endogenous entry fits aggregate quantities while featuring a higher risk premium when changes in growth variety are properly accounted. Moreover, adding the growth rate of establishments, as a proxy for growth variety, helps the standard consumption-based model to deliver lower pricing errors for the cross-section of stock returns.
Keywords: Extensive Margin, Entry, CCAPM, Equity Premium
JEL Classification: E32, G12.
Suggested Citation: Suggested Citation