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  3. American Economic Review
  4. September 2000
  5. Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

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

  • Stephen G. Cecchetti
  • Pok-sang Lam
  • Nelson C. Mark
American Economic Review
vol. 90, no. 4, September 2000
(pp. 787–805)
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Abstract

We study a Lucas asset-pricing model that is standard in all respects, except that the representative agent's subjective beliefs about endowment growth are distorted. Using constant relative risk-aversion (CRRA) utility, with a CRRA coefficient below 10; fluctuating beliefs that exhibit, on average, excessive pessimism over expansions; and excessive optimism over contractions (both ending more quickly than the data suggest), our model is able to match the first and second moments of the equity premium and risk-free rate, as well as he persistence and predictability of excess returns found in the data.

Citation

Cecchetti, Stephen, G., Pok-sang Lam, and Nelson C. Mark. 2000. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?" American Economic Review, 90 (4): 787–805. DOI: 10.1257/aer.90.4.787

JEL Classification

  • G12 Asset Pricing; Trading volume; Bond Interest Rates
  • E44 Financial Markets and the Macroeconomy