Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)
Knut K. Aase
Beyond the local mean-variance analysis in continuous time: The problem of non-normality
() and Jostein Lillestøl
Abstract: The paper investigates the effects of deviations from
normality on the estimates of risk premiums and the real equilibrium,
short-term interest rate in the conventional rational expectations
equilibrium model of Lucas (1978). We consider a time-continuous approach,
where both the aggregate consumption process as well as cumulative
dividends from risky assets are assumed to be jump-diusion processes. This
approach allows for random jumps in the fundamental underlying processes at
random time points. Preferences are time separable and additive. We derive
testable expressions for these quantities, and confront these with 20.
century sample estimates. Since there are non-linear components in the
formulas for the risk premiums and the interest rate, we can readily
explore what effect deviation from normality has on these quantities. Our
results test the boundaries of the conventional model.
Keywords: Mean-variance analysis; Consumption based CAPM; Equilibrium real interest rate; The equity premium puzzle; jump-diffusions; Bi-variate Normal Inverse Gaussian distribution; (follow links to similar papers)
JEL-Codes: D50; G10; G12; (follow links to similar papers)
22 pages, February 23, 2015
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