Beker, Pablo and Espino, Emilio (2013) Too good to be true : asset pricing implications of pessimism. Working Paper. Coventry, UK: Department of Economics, University of Warwick. Warwick economics research papers series (TWERPS), Volume 2013 (Number 1031).

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Abstract

We evaluate whether the introduction of pessimistic homogeneous beliefs in the frictionless
Lucas-Mehra-Prescott model and the Kehoe-Levine-Alvarez-Jermann model with endogenous bor-
rowing constraints, helps explain the equity premium, the risk-free rate and the equity volatility
puzzles as well as the short-term momentum and long-term reversal of excess returns. We cal-
ibrate the model to U.S. data as in Alvarez and Jermann [4] and we find that the data does
not contradict the qualitative predictions of the models. When the preferences parameters are
disciplined to match both the average annual risk-free rate and equity premium, the Lucas-Mehra-
Prescott model gives a more quantitatively accurate explanation for short-term momentum than
the Kehoe-Levine-Alvarez-Jermann model but the latter gives a more quantitatively accurate ex-
planation for the equity volatility puzzle. Long-term reversal remains quantitatively unexplained
in both models.

Item Type:	Working or Discussion Paper (Working Paper)
Subjects:	H Social Sciences > HB Economic Theory
Divisions:	Faculty of Social Sciences > Economics
Library of Congress Subject Headings (LCSH):	Economics -- Mathematical models , Credit, Stocks
Series Name:	Warwick economics research papers series (TWERPS)
Publisher:	Department of Economics, University of Warwick
Place of Publication:	Coventry, UK
Official Date:	2013
Volume:	Volume 2013
Number:	Number 1031
Number of Pages:	32
Status:	Not Peer Reviewed
Publication Status:	Published

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