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The Importance of Investor Heterogeneity and Financial Market Imperfections for the Behavior of Asset Prices

Excerpt from The Importance of Investor Heterogeneity and Financial Market Imperfections for the Behavior of Asset Prices Many features of asset prices and investment behavior have proven hard to explain using simple parametric versions of representative agent models estimated with aggregate consumption data. One of the most often cited difficulties is in reconciling the large spread between the mean return on stocks and bonds-the equity premium puzzle of Mehra and Prescott Not only is the predicted equity premium too low (assuming moderate levels of risk aversion), but the predicted risk-free rate is too high (for plausible rates of time preference). This latter puzzle is known as the risk-free rate puzzle [well Closely related is the fact that observed holdings of risk-free assets greatly exceed predicted holdings in models in which asset returns are taken as given and quantities are chosen to clear markets. The representative agent model also appears unable to explain the term structure of interest rates (backus, Gregory, and Zin or to match the second moments and correlation structure of asset returns. These pricing puzzles are to a large extent due to the fact that aggregate consumption is not very risky, which implies that a moderately risk-averse representative agent demands only a small premium to hold stocks over risk-free bonds, and has a low precautionary demand for savings. Representative agent models also are not designed to explain asset market phenomena such as the high concentration of stock ownership and the large volume of trade. About the Publisher Forgotten Books publishes hundreds of thousands of rare and classic books. Find more at This book is a reproduction of an important historical work. Forgotten Books uses state-of-the-art technology to digitally reconstruct the work, preserving the original format whilst repairing imperfections present in the aged copy. In rare cases, an imperfection in the original, such as a blemish or missing page, may be replicated in our edition. We do, however, repair the vast majority of imperfections successfully; any imperfections that remain are intentionally left to preserve the state of such historical works.
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