Asset Pricing Implications of Pareto Optimality with Private Information

60 Pages Posted: 24 Jun 2005

See all articles by Narayana Kocherlakota

Narayana Kocherlakota

University of Minnesota - Twin Cities - Department of Economics

Luigi Pistaferri

Stanford University; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2005

Abstract

In this paper, we consider a dynamic economy in which the agents are privately informed about their skills, which evolve stochastically over time in an arbitrary fashion. We consider an asset pricing equilibrium in which equilibrium quantities are constrained Pareto optimal. Under the assumption that agents have constant relative risk aversion, we derive a novel asset pricing kernel for financial asset returns. The kernel equals the reciprocal of the gross growth of the x-th moment of the consumption distribution, where x is the coefficient of relative risk aversion. We use data from the Consumer Expenditure Survey (CEX) and show that the new stochastic discount factor performs better than existing stochastic discount factors at rationalizing the equity premium. However, its ability to simultaneously explain the equity premium and the expected return to the Treasury bill is about the same as existing discount factors.

Keywords: Asset pricing, consumer expenditure survey

JEL Classification: E21, G12

Suggested Citation

Kocherlakota, Narayana and Pistaferri, Luigi, Asset Pricing Implications of Pareto Optimality with Private Information (February 2005). CEPR Discussion Paper No. 4930. Available at SSRN: https://ssrn.com/abstract=751946

Narayana Kocherlakota

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
Minneapolis, MN 55455
United States
612-625-5318 (Phone)
612-624-0209 (Fax)

HOME PAGE: http://www.econ.umn.edu/~nkocher/

Luigi Pistaferri (Contact Author)

Stanford University ( email )

Stanford, CA 94305
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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