TY  - JOUR
AU  - Cecchetti,Stephen G.
AU  - Lam,Pok-sang
AU  - Clark,Nelson C.
TI  - The Equity Premium and the Risk Free Rate:  Matching the Moments
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 3752
PY  - 1991
Y2  - June 1991
UR  - http://www.nber.org/papers/w3752
L1  - http://www.nber.org/papers/w3752.pdf
N1  - Author contact info:
Stephen G. Cecchetti
Monetary and Economic Department
Bank for International Settlements
Centralbahnplatz 2
4002 Basel
SWITZERLAND
Tel: +41 61 280 8350
Fax: +41 61 280 9113
E-Mail: stephen.cecchetti@bis.org

Pok-Sang Lam
Department of Economics
Ohio State University
1945 North High Street
Columbus, OH   43210-1172
Tel: 614/292-6702
AB  - This paper investigates the ability of a representative agent model with time separable utility to explain the mean vector and the covariance matrix of the risk free interest rate and the return to leveraged equity in the stock market. The paper generalizes the standard calibration methodology by accounting for the uncertainty in both the sample moments to be explained and the estimated parameters to which the model is calibrated. We develop a testing framework to evaluate the model's ability to match the moments of the data. We study two forms of the model, both of which treat leverage in a manner consistent with the data. In the first, dividends explicitly represent the flow that accrues to the owner of the equity, and they are discounted by the marginal rate of intertemporal substitution defined over consumption. The second form of the model introduces bonds and treats equities as the residual claim to the total endowment stream. We find that the first moments of the data can be matched for a wide range of preference parameter values. But for both models the implied first and second moments taken together are always statistically significantly different from the data at standard levels. This last result contrasts sharply with other recent treatments of leverage in the literature.
ER  -