NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Asset Prices in a Lifecycle Economy

Roger Farmer

NBER Working Paper No. 19958
Issued in March 2014
NBER Program(s):   EFG   IFM

The representative agent model (RA) has dominated macroeconomics for the last thirty years. This model does a reasonably good job of explaining the co-movements of consumption, investment, GDP and employment during normal times. But it cannot easily explain movements in asset prices. Two facts are hard to understand 1) The return to equity is highly volatile and 2) The premium for holding equity, over a safe government bond, is large. The equity premium has two parts; a risk premium and a term premium. This paper constructs a lifecycle model in which agents of different generations have different savings rates and I use this model to account for a high term premium and a volatile stochastic discount factor. The fact the term premium is large, accounts for a substantial part of the observed equity premium.

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This paper was revised on March 20, 2014

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Document Object Identifier (DOI): 10.3386/w19958

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