() and Paul Söderlind
Paolo Giordani: Dept. of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Paul Söderlind: Dept. of Finance, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Abstract: Abel (2002) shows that pessimism and doubt in the subjective distribution of the growth rate of consumption reduce the riskfree rate puzzle and the equity premium puzzle. We quantify the amount of pessimism and doubt in survey data on US consumption and income. Individual forecasters are in fact pessimistic, but show marked overconfidence rather than doubt. Whether this implies that overconfidence should be built into Abel's model depends on how the empirically heterogeneous subjective distributions are mapped into the distribution of a fictitious representative agent. We work out the form of this mapping in an Arrow-Debreu economy and show that the equity premium increases with the dispersion of beliefs. We then estimate this aggregate distribution and find little evidence of either overconfidence or doubt.
14 pages, First version: December 14, 2002. Revised: October 1, 2003. Earlier revisions: August 15, 2003.
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