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 Publisher Website: 10.1016/B9780444508997.50018X
 Scopus: eid_2s2.084882924344
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Book Chapter: Cash Flow Risk, Discounting Risk, and the Equity Premium Puzzle
Title  Cash Flow Risk, Discounting Risk, and the Equity Premium Puzzle 

Authors  
Issue Date  2008 
Publisher  Elsevier 
Citation  Cash Flow Risk, Discounting Risk, and the Equity Premium Puzzle. In Mehra, R (Ed.), Handbook of the equity risk premium, p. 377402. Amsterdam ; Boston: Elsevier, 2008 How to Cite? 
Abstract  This article investigates the impact of cash flow risk and discounting risk on the aggregate equity premium. Our approach is based on the idea that consumption is hard to measure empirically, so if we substitute out an empirically difficulttoestimate marginal utility by a pricing kernel of observables, we can evaluate the empirical performance of an equilibrium asset pricing model in a different way. Once the pricingkernel process is specified, we can endogenously solve for the equity premium, the price of the market portfolio, and the term structure of interest rates within the same underlying equilibrium. Embedded in the closedform solution are compensations for cash flow risk and discounting risk. With the solution for the risk premium explicitly given, we then calibrate the model to evaluate its empirical performance. This approach allows us to avoid the impact of the unobservable consumption or market portfolio on inferences regarding the model's performance. Our illustrative model is based on the assumption that aggregate dividend equals a fixed fraction of aggregate earnings plus noise, and the expected aggregate earnings growth follows a meanreverting stochastic process. Moreover, the economywide pricing kernel is chosen to be consistent with (1) a constant market price of aggregate risk and (2) a meanreverting interest rate process with constant volatility. Estimation results show that the framework can mimic the observed market equity premium. 
Persistent Identifier  http://hdl.handle.net/10722/222283 
ISBN  
Series/Report no.  Handbooks in finance 
DC Field  Value  Language 

dc.contributor.author  Bakshi, G   
dc.contributor.author  Chen, Z   
dc.date.accessioned  20160111T04:34:46Z   
dc.date.available  20160111T04:34:46Z   
dc.date.issued  2008   
dc.identifier.citation  Cash Flow Risk, Discounting Risk, and the Equity Premium Puzzle. In Mehra, R (Ed.), Handbook of the equity risk premium, p. 377402. Amsterdam ; Boston: Elsevier, 2008   
dc.identifier.isbn  9780444508997   
dc.identifier.uri  http://hdl.handle.net/10722/222283   
dc.description.abstract  This article investigates the impact of cash flow risk and discounting risk on the aggregate equity premium. Our approach is based on the idea that consumption is hard to measure empirically, so if we substitute out an empirically difficulttoestimate marginal utility by a pricing kernel of observables, we can evaluate the empirical performance of an equilibrium asset pricing model in a different way. Once the pricingkernel process is specified, we can endogenously solve for the equity premium, the price of the market portfolio, and the term structure of interest rates within the same underlying equilibrium. Embedded in the closedform solution are compensations for cash flow risk and discounting risk. With the solution for the risk premium explicitly given, we then calibrate the model to evaluate its empirical performance. This approach allows us to avoid the impact of the unobservable consumption or market portfolio on inferences regarding the model's performance. Our illustrative model is based on the assumption that aggregate dividend equals a fixed fraction of aggregate earnings plus noise, and the expected aggregate earnings growth follows a meanreverting stochastic process. Moreover, the economywide pricing kernel is chosen to be consistent with (1) a constant market price of aggregate risk and (2) a meanreverting interest rate process with constant volatility. Estimation results show that the framework can mimic the observed market equity premium.   
dc.language  eng   
dc.publisher  Elsevier   
dc.relation.ispartof  Handbook of the equity risk premium   
dc.relation.ispartofseries  Handbooks in finance   
dc.title  Cash Flow Risk, Discounting Risk, and the Equity Premium Puzzle   
dc.type  Book_Chapter   
dc.identifier.email  Chen, Z: zchen99@hku.hk   
dc.identifier.authority  Chen, Z=rp02041   
dc.identifier.doi  10.1016/B9780444508997.50018X   
dc.identifier.scopus  eid_2s2.084882924344   
dc.identifier.spage  377   
dc.identifier.epage  402   
dc.publisher.place  Amsterdam ; Boston   