Consumption-Based Asset Pricing

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What is the conceptual view that incorporates all risk correlations for any asset?

A change of measure

A single (random) variable Mt+1 to discount payoffs with (correct)

A Marginal rate of substitution

A complete set of competitive markets

What is the formula for the payoff of an asset in multiple periods?

Pi,t = Et [Mt+1 (Di,t+1 - Pi,t+1 )]

Pi,t = Et [Mt+1 (Di,t+1 + Pi,t+1 )] (correct)

Pi,t = Et [Mt+1 /(Di,t+1 + Pi,t+1 )]

Pi,t = Et [Mt+1 (Di,t+1 * Pi,t+1 )]

What is the price of the Arrow security that pays $1 if state s occurs at time t+1 and zero otherwise?

πs,t+1

Xs,t+1

Ps,t,t+1 (correct)

Ms,t+1

What is the implication of the equation Pi,t = Et [Mt+1 Xt+1 ]?

Ms,t+1 = Ps,t,t+1 / πs,t+1 Signup and view all the answers

What is the Modigliani-Miller theorem?

Value of an asset is the sum of its parts Signup and view all the answers

Why doesn't the capital structure of a firm affect its value?

Due to arbitrage Signup and view all the answers

Under what condition does the Modigliani-Miller theorem hold?

Complete markets and no taxes Signup and view all the answers

Does hedging a risk raise the value of a firm?

No, never Signup and view all the answers

What is the primary concern of consumption-based asset pricing?

Understanding the relationship between consumption and asset prices Signup and view all the answers

What is the purpose of the Consumption Euler equation?

To derive the fundamental equation of consumption-based asset pricing Signup and view all the answers

What is the return on an asset defined as?

The payoff of the asset divided by the price Signup and view all the answers

What is the stochastic discount factor?

A discount factor that varies with uncertainty Signup and view all the answers

What is the fundamental equation of consumption-based asset pricing?

Pi,t = Et [Mt+1 Xi,t+1] Signup and view all the answers

What is the role of the stochastic discount factor in consumption-based asset pricing?

To price all assets Signup and view all the answers

What is the relationship between the stochastic discount factor and the standard discount factor?

The stochastic discount factor generalizes the standard discount factor Signup and view all the answers

What is the purpose of the two perspectives in the Consumption Euler equation?

To relate consumption to asset prices Signup and view all the answers

What is the main difference between the geometric and arithmetic returns in the context of asset pricing?

Geometric mean is a logarithmic function, while arithmetic mean is a linear function. Signup and view all the answers

What is the approximate standard deviation of the annual real return on stocks?

18% Signup and view all the answers

What is the relationship between the log of expected gross return and the expected net return?

Log of expected gross return is approximately equal to the expected net return for small x. Signup and view all the answers

What is the assumption about the representative agent's preferences in the Mehra-Prescott 1985 model?

Constant relative risk aversion (CRRA) Signup and view all the answers

What is the equation for the equity premium in the Mehra-Prescott 1985 model?

log Et RC,t+1 − log Rf ,t = γvart (∆ log Ct+1 ) Signup and view all the answers

What is the nature of the consumption process in the endowment economy of the Mehra-Prescott 1985 model?

Logarithmic growth with a constant variance. Signup and view all the answers

What is the equation for the risk-free rate in the Mehra-Prescott 1985 model?

log Rf ,t = δ + γEt [∆ log Ct+1 ] − γ2 vart (∆ log Ct+1 ) Signup and view all the answers

What is the main objective of the Mehra-Prescott 1985 model?

To fit the model to the data and explain the equity premium puzzle. Signup and view all the answers

Which vector represents the state of the world in the future?

S Signup and view all the answers

What does the expression $Pt imes Xt+1$ represent?

Value of Firm A before hedging risk Signup and view all the answers

According to Modigliani-Miller theorem, what remains unchanged when a firm purchases another cashflow?

The firm's value Signup and view all the answers

What kind of research do Ketchup Economists focus on?

Hard data on transactions Signup and view all the answers

What does CRRA stand for in the context of utility functions?

Constant relative risk aversion Signup and view all the answers

What is the equation for relative risk aversion in the given context?

<ul> <li>(U''(C)C / U'(C)) = γ</li> </ul> Signup and view all the answers

Two quart-sized ketchup bottles invariably sell for what price according to Ketchup Economists?

Twice as much as one bottle Signup and view all the answers

In portfolio choice, how is the fraction allocated to a risky asset determined?

It is independent of wealth Signup and view all the answers

What does $eta$ represent in the context of the power utility function?

Discount factor Signup and view all the answers

In the context of consumption-based asset pricing, what does the term $1/Et[M_{t+1}]$ represent?

Risk-free rate Signup and view all the answers

How is the intertemporal elasticity of substitution related to $ ext{γ}$ in the power utility function?

It is the inverse of $ ext{γ}$ Signup and view all the answers

In risk adjustments, when is an asset considered a hedge?

When its payoff covaries negatively with consumption Signup and view all the answers

Which term represents precautionary savings in the risk-free rate equation?

$ ext{γ}^2 ext{σ}t^2 (Δ ext{log} ext{C}{t+1})$ Signup and view all the answers

According to the equity premium formula, what does the covariance term represent?

Covariance between consumption growth and return on equity Signup and view all the answers

What is implied when the return on an asset is negatively correlated with $M_{t+1}$?

The asset has a high risk premium Signup and view all the answers

What does the expression $P_{i,t} = rac{E[X_{i,t+1}]}{R_{f,t}} + ext{cov}t(M{t+1}, X_{i,t+1})$ describe?

Price of an asset with risk adjustments Signup and view all the answers

Which condition under power utility indicates an asset is a hedge?

Payoff covaries negatively with consumption Signup and view all the answers

What term is added to the equity premium formula to account for the log-normal assumption?

$rac{1}{2} ext{σ}t^2( ext{log} ext{R}{i,t+1})$ Signup and view all the answers