Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good To Be True?

Stephen G. Cecchetti, Pok-sang Lam, Nelson C. Mark

NBER Working Paper No. 6354
Issued in January 1998
NBER Program(s):   AP

We study a Lucas asset pricing model that is standard in all respects representative agent's subjective beliefs about endowment growth are distorted. Using constant-relative-risk-aversion (CRRA) utility a CRRA coefficient below ten that exhibit, on average, excessive pessimism over expansions and excessive optimism over" contractions, our model is able to match the first and second moments of the equity premium and" risk-free rate, as well as the persistence and predictability of excess returns found in the data."

(1024 K)

Published: Cecchetti, Stephen G., Pok-sang Lam and Nelson C. Mark. "Asset Pricing With Distorted Beliefs: Are Equity Returns To Good To Be True?," American Economic Review, 2000, v90(4,Sep), 787-805.

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