Arbeitspapier

Idiosyncratic risk and volatility bounds, or can models with idiosyncratic risk solve the equity premium puzzle?

This paper uses Hansen and Jagannathan's (1991) volatility bounds to evaluate models with idiosyncratic consumption risk. I show that idiosyncratic risk does not change the volatility bounds at all when consumers have CRRA preferences and the distribution of the idiosyncratic shock is independent of the aggregate state. Following Mankiw (1986), I then show that idiosyncratic risk can help to enter the bounds when idiosyncratic uncertainty depends on the aggregate state of the economy. Since individual consumption data are not reliable, I compute an upper bound of the volatility bounds using individual income data and assume that agents have to consume their endowment. I find that the model does not pass the Hansen and Jagannathan test even for very volatile idiosyncratic income data.

Language
Englisch

Bibliographic citation
Series: Staff Report ; No. 130

Classification
Wirtschaft
Financial Markets and the Macroeconomy
Portfolio Choice; Investment Decisions
Asset Pricing; Trading Volume; Bond Interest Rates
Subject
idiosyncratic risk, risk premia, volatility bounds, asset prices, incomplete markets
Capital Asset Pricing Model
Risiko
Risikoprämie
Volatilität
Verbraucherausgaben
Theorie

Event
Geistige Schöpfung
(who)
Lettau, Martin
Event
Veröffentlichung
(who)
Federal Reserve Bank of New York
(where)
New York, NY
(when)
2001

Handle
Last update
10.03.2025, 11:42 AM CET

Data provider

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Object type

  • Arbeitspapier

Associated

  • Lettau, Martin
  • Federal Reserve Bank of New York

Time of origin

  • 2001

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