Working Paper: CEPR ID: DP1353
Authors: Jean-Pierre Danthine; John B. Donaldson
Abstract: This paper studies the pricing of financial assets in a complete general equilibrium set-up. We begin with an asset pricing model à la Lucas grafted on a standard Real Business Cycles model. We provide a new decentralized interpretation of such a model in which firms make meaningful investment decisions. We then confront qualitatively and quantitatively the implications of this model with financial observations. Drawing lessons from this exercise, we progressively enrich the model by introducing costs of adjusting the stock of capital, corporate debt and risk-sharing labour contracts. We find the latter to be particularly important in reconciling the model?s predictions with observations. We conclude that additional progress towards solving outstanding puzzles may come as much from a richer modelling of the real side of our economies as from further refinements in the description of the financial sector.
Keywords: excess volatility; risk premium; labour contracts
JEL Codes: E32; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| costs of adjusting the stock of capital (G31) | discrepancy between the return on physical capital and the return on financial assets (G19) |
| costs of adjusting the stock of capital (G31) | variability of asset returns (G17) |
| corporate debt (G32) | volatility of equity returns (G17) |
| corporate debt (G32) | average equity returns (G12) |
| risk-sharing labour contracts (J41) | asset pricing (G19) |
| risk-sharing labour contracts (J41) | consumption smoothing for workers (D15) |
| risk-sharing labour contracts (J41) | higher equity premium (G19) |