Working Paper: CEPR ID: DP4068
Authors: Paolo Giordani; Paul Soderlind
Abstract: Abel (2002) shows that pessimism and doubt in the subjective distribution of the growth rate of consumption reduce the risk-free rate puzzle and the equity premium puzzle. We quantify the amount of pessimism and doubt in survey data on US consumption and income. Individual forecasters are, in fact, pessimistic, but show marked overconfidence rather than doubt. Whether this implies that overconfidence should be built into Abel?s model depends on how the empirically heterogeneous subjective distributions are mapped into the distribution of a fictitious representative agent. We work out the form of this mapping in an Arrow-Debreu economy and show that the equity premium increases with the dispersion of beliefs. We then estimate this aggregate distribution and find little evidence of either overconfidence or doubt.
Keywords: aggregation of beliefs; equity premium; Livingston survey; risk-free rate; survey of professional forecasters
JEL Codes: C42; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| pessimism (D84) | equity premium (G12) |
| doubt (Y60) | equity premium (G12) |
| subjective distributions (C46) | empirical performance of asset pricing models (G17) |
| forecasted growth rates (F17) | actual outcomes (P47) |