Asset Pricing with Heterogeneous Agents and Long-Run Risk

67 Pages Posted: 9 Nov 2017 Last revised: 24 Sep 2018

See all articles by Walt Pohl

Walt Pohl

NHH Norwegian School of Economics; University of Zurich

Karl Schmedders

University of Zurich

Ole Wilms

Tilburg School of Economics and Management

Date Written: September 19, 2018

Abstract

This paper examines the effects of the heterogeneity of agents' beliefs about the persistence of long-run risks in consumption-based asset-pricing models. Agents who believe in a lower persistence level dominate the economy rather quickly, even if their belief is wrong. In a standard calibration of the long-run risk model, this dominance drives the equity premium down below the level observed in the data. Simultaneously, belief heterogeneity can generate significant excess volatility and priced consumption risk due to changes in the wealth distribution. This effect in turn helps to explain several asset-pricing puzzles such as the large countercyclical variation of expected risk premia, the volatility of the price--dividend ratio, and the predictability of cash flows and returns. A new calibration of the heterogeneous-agents long-run risk model can simultaneously explain the large equity premium and the aforementioned puzzles.

Keywords: asset pricing, long-run risk, recursive preferences, heterogeneous agents

JEL Classification: G11, G12

Suggested Citation

Pohl, Walt and Schmedders, Karl and Wilms, Ole, Asset Pricing with Heterogeneous Agents and Long-Run Risk (September 19, 2018). Available at SSRN: https://ssrn.com/abstract=3066637 or http://dx.doi.org/10.2139/ssrn.3066637

Walt Pohl

NHH Norwegian School of Economics ( email )

Helleveien 30
N-5045 Bergen
Norway

University of Zurich ( email )

Moussonstrasse 15
Zürich, 8044
Switzerland

Karl Schmedders

University of Zurich ( email )

Moussonstrasse 15
Zürich, CH-8044
Switzerland
+41 (0)44 634 3770 (Phone)

Ole Wilms (Contact Author)

Tilburg School of Economics and Management ( email )

PO Box 90153
Tilburg, 5000 LE Ti
Netherlands

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