Working Paper: CEPR ID: DP1884
Authors: Martin Lettau
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 premiumis small and often negative. The closed-form solutions presented here are applicable to any RBC model that can be approximated in loglinear form.
Keywords: asset prices; risk premia; RBC model; analytical solution; log-linear approximation
JEL Codes: E13; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| technology shocks (D89) | asset prices (G19) |
| technology shocks (D89) | consumption (E21) |
| consumption (E21) | interest rates (E43) |
| interest rates (E43) | expected returns on financial assets (G12) |
| technology shocks (D89) | risk premia (G22) |
| risk premia (G22) | asset prices (G19) |