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Discussion Paper Details

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Title: Inspecting the Mechanism: The Determination of Asset Prices in the Real Business Cycle Model

Author(s): Martin Lettau

Publication Date: May 1998

Keyword(s): analytical solution, Asset Prices, loglinear approximation, RBC model and Risk Premia

Programme Area(s): Financial Economics and International Macroeconomics

Abstract: In this paper, we derive closed-form solutions for a variety of prices for financial assets in an RBC economy. The equations are based on a loglinear solution of the RBC model and allow a clearer understanding of the determination of risk premia in models with production. E.g., we show that risk premia of long real bonds and equity are negative when technology shocks are permanent. Moreover, the wedge between the equity premium and the long bond premium is small and often negative. The closed-form solutions presented here are applicable to any RBC model that can be approximated in loglinear form.

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Bibliographic Reference

Lettau, M. 1998. 'Inspecting the Mechanism: The Determination of Asset Prices in the Real Business Cycle Model'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=1884