Revisiting Asset Pricing with Uncertainty in Future Preferences

69 Pages Posted: 12 Dec 2017 Last revised: 21 Sep 2018

See all articles by Mark Clements

Mark Clements

Los Angeles Capital Management

Christian L. Goulding

Auburn University - Harbert College of Business

Date Written: September 10, 2018

Abstract

We demonstrate that uncertainty about future preferences is of first-order importance for understanding the history of aggregate asset prices. Our analysis shows that simply relaxing the assumption of deterministic aggregate elasticity of intertemporal substitution and relative risk aversion can resolve a large array of aggregate asset pricing puzzles. These puzzles include the high equity premium, low risk-free rate, and the predictability (and nonpredictability) relationships among price-dividend ratios, excess returns, and consumption or dividend growth. Our model also generates time variation of dividend yields, risk premia, excess return volatilities, and Sharpe ratios, as well as an upward-sloping real yield curve.

Keywords: Equity Premium Puzzle, Elasticity of Intertemporal Substitution, Epstein-Zin Preferences, Real Term Structure, Risk Aversion, Predictability, Time-Varying Preferences

JEL Classification: G12, E44, G02

Suggested Citation

Clements, Mark and Goulding, Christian L., Revisiting Asset Pricing with Uncertainty in Future Preferences (September 10, 2018). Available at SSRN: https://ssrn.com/abstract=3086375 or http://dx.doi.org/10.2139/ssrn.3086375

Mark Clements

Los Angeles Capital Management ( email )

Los Angeles, CA 90025
United States

Christian L. Goulding (Contact Author)

Auburn University - Harbert College of Business ( email )

Auburn, AL 36849
United States

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