ELUCIDATING EQUITY PREMIUM USING CORPORATE DIVIDENDS AND HABIT FORMATION

2015 ◽  
Vol 10 (02) ◽  
pp. 1550014
Author(s):  
JOW-RAN CHANG ◽  
HSU-HSIEN CHU
Keyword(s):  
Habit Formation ◽  
Diffusion Processes ◽  
Equity Premium ◽  
Closed Form Solutions ◽  
Consumption Ratio ◽  
Jump Diffusion Processes ◽  
Risk Free Rate ◽  
Stock Values ◽  
Special Case ◽  
Free Rate

This paper extends Longstaff and Piazzesi (2004, Journal of Financial Economics, 74, 401–421.) to a habit formation model. By combining corporate fraction ratio, and surplus consumption ratio, we derive closed-form solutions for stock values when dividends, habit ratio and consumption follow exponential affine jump-diffusion processes. We can prove that Longstaff and Piazzesi (2004) is only a special case of our model. In addition, calibrated results show that the corporate fraction and habit ratio to shocks significantly increases the equity premium and decreases the risk-free rate. The model determines realistic values for the equity premium and the risk-free rate.

A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles

1996 ◽  
Vol 104 (6) ◽  
pp. 1135-1171 ◽  
Author(s):  
Ravi Bansal ◽  
Wilbur John Coleman
Keyword(s):  
Equity Premium ◽  
Term Premium ◽  
Risk Free Rate ◽  
Free Rate

IMPLICATION OF THE KELLY CRITERION FOR MULTI-DIMENSIONAL PROCESSES

2010 ◽  
Vol 13 (01) ◽  
pp. 93-112 ◽  
Author(s):  
YINGDONG LV ◽  
BERNHARD K. MEISTER
Keyword(s):  
Financial Markets ◽  
Diffusion Processes ◽  
General Setting ◽  
Optimal Investment ◽  
Investment Strategy ◽  
Short Term ◽  
Kelly Criterion ◽  
Optimal Investment Strategy ◽  
Risk Free Rate ◽  
Free Rate

In this paper, we study the Kelly criterion in the continuous time framework building on the work of E.O. Thorp and others. The existence of an optimal strategy is proven in a general setting and the corresponding optimal wealth process is found. A simple formula is provided for calculating the optimal portfolio in terms of drift, short term risk-free rate and correlations for a set of generic multi-dimensional diffusion processes satisfying some simple conditions. Properties of the optimal investment strategy are studied. The paper ends with a short discussion of the implications of these ideas for financial markets.

scholarly journals The Risk Averse Investor's Equilibrium Equity Premium in a Semi Martingale Market with Arbitrary Jumps

2016 ◽  
Vol 8 (6) ◽  
pp. 139
Author(s):  
George M. Mukupa ◽  
Elias R. Offen ◽  
Edward M. Lungu
Keyword(s):  
Utility Function ◽  
Risk Premium ◽  
Rare Event ◽  
Equity Premium ◽  
Risk Averse ◽  
Bond Price ◽  
Risk Free Rate ◽  
Negative Exponential ◽  
Exponential Utility Function ◽  
Free Rate

In this paper, we study the risk averse investor's equilibrium equity premium in a semi martingale market with arbitrary jumps. We realize that,  if we normalize the market, the equilibrium equity premium is consistent to taking the risk free rate $\rho=0$ in martingale markets. We also observe that the value process affects both the diffusive and rare-event premia except for the CARA negative exponential utility function. The bond price always affect the diffusive risk premium for this risk averse investor.

scholarly journals Ambiguity Aversion and the Variance Premium

2019 ◽  
Vol 09 (02) ◽  
pp. 1950003 ◽  
Author(s):  
Jianjun Miao ◽  
Bin Wei ◽  
Hao Zhou
Keyword(s):  
Risk Aversion ◽  
Ambiguity Aversion ◽  
Equity Premium ◽  
Return Variance ◽  
Quantitative Performance ◽  
The Mean ◽  
The Difference ◽  
Risk Free Rate ◽  
Mean Variance ◽  
Free Rate

This paper offers an ambiguity-based interpretation of the variance premium — the difference between risk-neutral and objective expectations of market return variance — as a compounding effect of both belief distortion and variance differential regarding the uncertain economic regimes. Our calibrated model can match the variance premium, the equity premium, and the risk-free rate in the data. We find that about 97% of the mean–variance premium can be attributed to ambiguity aversion. A three-way separation among ambiguity aversion, risk aversion, and intertemporal substitution, permitted by the smooth ambiguity preferences, plays a key role in our model’s quantitative performance.

scholarly journals Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?

2000 ◽  
Vol 90 (4) ◽  
pp. 787-805 ◽  
Author(s):  
Stephen G Cecchetti ◽  
Pok-Sang Lam ◽  
Nelson C Mark
Keyword(s):  
Asset Pricing ◽  
Equity Premium ◽  
Equity Returns ◽  
Relative Risk Aversion ◽  
Pricing Model ◽  
Asset Pricing Model ◽  
Subjective Beliefs ◽  
Second Moments ◽  
Risk Free Rate ◽  
Free Rate

We study a Lucas asset-pricing model that is standard in all respects, except that the representative agent's subjective beliefs about endowment growth are distorted. Using constant relative risk-aversion (CRRA) utility, with a CRRA coefficient below 10; fluctuating beliefs that exhibit, on average, excessive pessimism over expansions; and excessive optimism over contractions (both ending more quickly than the data suggest), our model is able to match the first and second moments of the equity premium and risk-free rate, as well as the persistence and predictability of excess returns found in the data. (JEL E44, G12)

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