Risk Premia: Exact Solutions vs. Log-Linear Approximations

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Abstract

We derive exact expressions for the risk premia for general distributions in a Lucas economy and show that the errors when using log-linear approximations can be economically significant when the shocks are nonnormal. Assuming growth rates are Normal Inverse Gaussian (NIG) and fitting the distribution to the data used in Mehra and Prescott (1985), the coefficient of relative risk aversion required to match the equity premium is more than halved compared to the finding in their article. We also consider a standard long-run risk model and, by comparing our exact solutions to the log-linear approximations, we show that the approximation errors are substantial, especially for high levels of risk aversion.

Detaljer

Författare
Enheter & grupper
Forskningsområden

Ämnesklassifikation (UKÄ) – OBLIGATORISK

  • Företagsekonomi
  • Nationalekonomi

Nyckelord

Originalspråkengelska
Sidor (från-till)4256-4264
TidskriftJournal of Banking & Finance
Volym37
Utgåva nummer11
StatusPublished - 2013
PublikationskategoriForskning
Peer review utfördJa