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CAN FINANCING CONSTRAINTS EXPLAIN THE ASSET PRICING PUZZLES IN PRODUCTION ECONOMIES? *
Author(s) -
Smith Katherine A.
Publication year - 2011
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/j.1468-2354.2011.00648.x
Subject(s) - stylized fact , economics , equity premium puzzle , capital asset pricing model , volatility (finance) , risk premium , consumption based capital asset pricing model , monetary economics , equity (law) , dynamic stochastic general equilibrium , financial economics , macroeconomics , monetary policy , political science , law
General Equilibrium asset pricing models have a difficult time simultaneously delivering a sizable equity premium, a low and counter cyclical real risk free rate, and cyclical variation in return volatility. To explain these stylized facts, this article introduces occasionally binding financing constraints that impede producers’ ability to invest. The financial frictions drive a wedge between the marginal rate of substitution and firms’ internal stochastic discount factors so that the shadow value of capital is not tied to the average price of capital. The model delivers higher and more volatile asset returns during recessions as well as a counter cyclical equity premium.