Asset Pricing with Return Extrapolation

Lawrence J. Jin, Pengfei Sui
2017 Social Science Research Network  
We develop a representative agent general equilibrium model with return extrapolation and recursive preferences. The model generates a large and countercyclical equity premium, a low and procyclical interest rate, a sizable and countercyclical Sharpe ratio, low interest rate volatility, strong excess volatility for equity, predictability of equity returns using price-dividend ratios, negative autocorrelations of equity returns, persistence of price-dividend ratios, as well as low correlations
more » ... low correlations between consumption growth and stock returns. In addition, the model matches in magnitude the degree of return extrapolation and the investor memory structure derived directly from survey evidence. Our model can serve as a quantitative benchmark for the comparison between behavioral asset pricing models and more traditional models. * We thank Nicholas Barberis, Robin Greenwood, Stefano Cassella, and our colleagues at the California Institute of Technology for helpful discussions. Please send correspondence to Lawrence J. Jin,
doi:10.2139/ssrn.3045658 fatcat:qnknay7vszf2vaamjsgx5n3vni