Knut K. Aase
Knut K. Aase: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
Abstract: Motivated by the problems of the conventional model in rationalizing market data, we derive the equilibrium interest rate and risk premiums using recursive utility in continuous time. In a representative-agent framework our model allows for the separation of risk aversion from the time preference. We demonstrate how this separation gives new insights in asset pricing: The expressions for risk premiums combine the market-based CAPM with the consumption-based CAPM. The equilibrium real interest rate now combines characterizations of preferences and market returns. This model explains both the Equity Premium Puzzle and the Risk-Free Rate Puzzle with good margin, and give solutions consistent with early resolution of uncertainty.
34 pages, November 16, 2012
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