Hostname: page-component-586b7cd67f-t7czq Total loading time: 0 Render date: 2024-11-26T04:04:42.875Z Has data issue: false hasContentIssue false
  • English
  • Français

Informational Asymmetry and Market Imperfections: Another Solution to the Equity Premium Puzzle

Published online by Cambridge University Press:  06 April 2009

Chunsheng Zhou
Chunsheng Zhou
Affiliation:
Anderson Graduate School of Management, University of California, Riverside, CA 92521.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper develops an equilibrium asset pricing model to explain the equity premium puzzle and the risk-free rate puzzle by allowing for both market frictions and informational asymmetry. The paper argues that much of the high equity premium in the Mehra and Prescott (1985).sample period can be explained by informational asymmetry among investors and the inability of many investors to diversify their portfolios. With admissible relative risk aversion coefficient γ, the model matches various key statistics quite well. The paper implies that with the development of mutual funds, the equity premium should decline as has been the case since the 1950s.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 34 , Issue 4 , December 1999 , pp. 445 - 464
Copyright
Copyright © School of Business Administration, University of Washington 1999

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Abel, A. “Asset Prices under Habit Formation and Catching up with the Joneses.” American Economic Review, Papers and Proceedings, 80 (1990), 38–42.Google Scholar
Aiyagari, S. R., and Gertler, M.. “Asset Returns with Transactions Costs and Uninsured Individual Risks.” Journal of Monetary Economics, 27 (1991), 311–331.CrossRefGoogle Scholar
Akerlof, G. A. “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism.” Quarterly Journal of Economics, 84 (1970), 488–500.CrossRefGoogle Scholar
Allen, F., and Gale, D.. “Limited Market Participation and Volatility of Asset Prices.” American Economic Review, 84 (1994), 933–955.Google Scholar
Blanchard, O. “Movements in the Equity Premium.” Brookings Papers on Economic Activity, (1993), 75–118.CrossRefGoogle Scholar
Bloomfield, T.; Leftwich, R.; and Long, J., Jr. “Portfolio Strategies and Performance.” Journal of Financial Economics, 5 (1977), 201–218.CrossRefGoogle Scholar
Breeden, D. “An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities.” Journal of Financial Economics, 7 (1979), 265–296.CrossRefGoogle Scholar
Brennan, M. J. “The Optimal Number of Securities in a Risky Asset Portfolio when There Are Fixed Costs of Transaction: Theory and Some Empirical Results.” Journal of Financial and Quantitative Analysis, 10 (1975), 483–496.CrossRefGoogle Scholar
Campbell, J. Y., and Cochrane, J.. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy, 107 (1999), 205–251.CrossRefGoogle Scholar
Constantinides, G. M. “Habit Formation: A Resolution of the Equity Premium Puzzle.” Journal of Political Economy, 98 (1990), 519–543.CrossRefGoogle Scholar
Constantinides, G. M.; Donaldson, J. B.; and Mehra, R.. “Junior Can't Borrow: New Perspective on the Equity Premium Puzzle.” Working Paper, Univ. of Chicago, Columbia Univ., and Univ. of California at Santa Barbara (1998).Google Scholar
DeLong, B.; Shleifer, A.; Summers, L.; and Waldmann, R.. “Noise Trader Risk in Financial Markets.” Journal of Political Economy, 98 (1990), 703–738.CrossRefGoogle Scholar
Dow, J., and Gorton, G.. “Profitable Informed Trading in a Simple General Equilibrium Model of Asset Pricing.” Journal of Economic Theory, 67 (1995), 327–369.CrossRefGoogle Scholar
Epstein, L. G., and Zin, S. E.. “Substitution, Risk Aversion, and Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis.” Journal of Political Economy, 99 (1991), 263–286.CrossRefGoogle Scholar
Grossman, S. J., and Shiller, R. J.. “The Determinants of the Variability of Stock Prices.” American Economic Review, 71 (1981), 222–227.Google Scholar
Grossman, S. J., and Stiglitz, J. E.. “On the Impossibility of Informational Efficient Markets.” American Economic Review, 70 (1980), 393–408.Google Scholar
Heaton, J., and Lucas, D.. “Asset Pricing with Uninsurable Risks and Trading Costs.” Working Paper, NBER (1993).Google Scholar
Hellwig, M. F. “On the Aggregation of Information in Competitive Markets.” Journal of Economic Theory, 22 (1980), 477–498.CrossRefGoogle Scholar
Kreps, D. M. “A Note on ‘Fulfilled Expectations’ Equilibrium.” Journal of Economic Theory, 14 (1977), 32–43.CrossRefGoogle Scholar
Kocherlakota, N. R. “The Equity Premium: It's still a Puzzle.” Journal of Economic Literature, 34 (1996), 42–71.Google Scholar
Kyle, A. S. “Continuous Auctions and Insider Trading.” Econometrica, 53 (1985), 1315–1335.CrossRefGoogle Scholar
Kyle, A. S. “Informed Speculation with Imperfect Competition.” Review of Economic Studies, 56 (1989), 317–356.CrossRefGoogle Scholar
Lucas, R. E. Jr. “Asset Prices in an Exchange Economy.” Econometrica, 46 (1978), 1429–1445.CrossRefGoogle Scholar
Mankiw, N. G., and Zeldes, S. P.. “The Consumption of Stockholders and Nonstockholders.” Journal of Financial Economics, 29 (1991), 97–112.CrossRefGoogle Scholar
Mehra, R., and Prescott, E. C.. “The Equity Premium, A Puzzle.” Journal of Monetary Economics, 15 (1985), 145–162.CrossRefGoogle Scholar
Merton, R. C. “An Intertemporal Asset Pricing Model.” Econometrica, 41 (1973), 867–887.CrossRefGoogle Scholar
Rock, K. “Why New Issues are Underpriced.” Journal of Financial Economics, 15 (1986), 187–212.CrossRefGoogle Scholar
Telmer, C. I. “Asset-Pricing Puzzles and Incomplete Markets.” Journal of Finance, 48 (1993), 1803–1832.Google Scholar
Wang, J. “A Model of Intertemporal Asset Prices Under Asymmetric Information.” Review of Economic Studies, 60 (1993), 249–282.CrossRefGoogle Scholar
Weil, P. “The Equity Premium Puzzle and the Risk-Free Rate Puzzle.” Journal of Monetary Economics, 24 (1989), 401–422.CrossRefGoogle Scholar
Zhou, C. “Dynamic Portfolio Choice and Asset Pricing with Differential Information.” Journal of Economic Dynamics and Control, 22 (1998), 1027–1051.CrossRefGoogle Scholar
Zhou, C. “Dynamic Portfolio Choice and Asset Pricing under Asymmetric Information.” Working Paper, Financial Research Center, Princeton Univ. (1995).Google Scholar
Zhou, C. “Term Premium, Equity Premium, and Riskfree Rate: All Puzzles or No Puzzles?” Working Paper, Univ. of California at Riverside (1999).Google Scholar