Risk premia and term premia in general equilibrium

Author / Creator

Abel, Andrew B., 1952-

Available as

Online

Summary

Abstract: The equity premium consists of a term premium reflecting the longer maturity of equity relative to short-term bills, and a risk premium reflecting the stochastic nature of equity payoffs ...

Abstract: The equity premium consists of a term premium reflecting the longer maturity of equity relative to short-term bills, and a risk premium reflecting the stochastic nature of equity payoffs and the deterministic nature of payoffs on reckless bills. This paper analyzes term premia and the risk premia in a general equilibrium model with catching up with the Joneses preferences and a novel formulation of leverage. Closed-form solutions for moments of asset returns are derived. First-order approximations illustrate the effects of parameters and provide an algorithm to match the means and variances of the riskless rate and the rate of return on equity.

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