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Discussion Paper Details

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Title: Asset Prices in a Lifecycle Economy

Author(s): Roger E A Farmer

Publication Date: March 2014

Keyword(s): asset prices, equity premium puzzle and excess volatility puzzle

Programme Area(s): International Macroeconomics

Abstract: The representative agent model (RA) has dominated macroeconomics for the last thirty years. This model does a reasonably good job of explaining the co-movements of consumption, investment, GDP and employment during normal times. But it cannot easily explain movements in asset prices. Two facts are hard to understand 1) The return to equity is highly volatile and 2) The premium for holding equity, over a safe government bond, is large. The equity premium has two parts; a risk premium and a term premium. This paper constructs a lifecycle model in which agents of different generations have different savings rates and I use this model to account for a high term premium and a volatile stochastic discount factor. The fact the term premium is large, accounts for a substantial part of the observed equity premium.

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Bibliographic Reference

Farmer, R. 2014. 'Asset Prices in a Lifecycle Economy'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=9897