Asset Pricing John H. Cochrane June 12, 2000

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CHAPTER 2 APPLYING THE BASIC MODEL find c and p in terms of truly exogenous forces. The results will of course depend on what the rest of the economy looks like, in particular the production or intertemporal transformation technology and the set of markets. Figure 2 shows one possibility for a general equilibrium. Suppose that the production technologies are linear: the real, physical rate of return (the rate of intertemporal transformation) is not affected by how much is invested. Now consumption must adjust to these technologically given rates of return. If the rates of return on the intertemporal technologies were to change, the consumption process would have to change as well. This is, implicitly, how the permanent income model works. This is how many finance theories such as the CAPM and ICAPM and the Cox, Ingersoll and Ross (1986) model of the term structure work as well. These models specify the return process, and then solve the consumer’s portfolio and consumption rules. C t+1 Figure 2. Consumption adjusts when the rate of return is determined by a linear technology. Figure 3 shows another extreme possibility for the production technology. This is an “endowment economy.” Nondurable consumption appears (or is produced by labor) every period. There is nothing anyone can do to save, store, invest or otherwise transform consumption goods this period to consumption goods next period. Hence, asset prices must adjust until people are just happy consuming the endowment process. In this case consumption is exogenous and asset prices adjust. Lucas (1978) and Mehra and Prescott (1985) are two very famous applications of this sort of “endowment economy.” Which of these possibilities is correct? Well, neither, of course. The real economy and all serious general equilibrium models look something like figure 4: one can save or transform consumption from one date to the next, but at a decreasing rate. As investment increases, 44 R C t
C t+1 SECTION 2.2 GENERAL EQUILIBRIUM Figure 3. <strong>Asset</strong> prices adjust to consumption in an endowment economy. rates of return decline C t+1 Figure 4. General equilibrium. The solid lines represent the indifference curve and production possibility set. The dashed straight line represents the equilibrium rate of return. The dashed box represents an endowment economy that predicts the same consumption-asset return process. 45 R R C t C t
Page 1 and 2: Asset Pricing John H. Cochrane June
Page 3 and 4: Contents Acknowledgments 2 Preface
Page 5 and 6: 9.2 Intertemporal Capital Asset Pri
Page 7 and 8: 19.2 Yield curve and expectations h
Page 9 and 10: Asset pricing problems are solved b
Page 11 and 12: try to focus on the basic ideas and
Page 13 and 14: Chapter 1. Consumption-based model
Page 15 and 16: SECTION 1.1 BASIC PRICING EQUATION
Page 17 and 18: discount factors, SECTION 1.3 PRICE
Page 19 and 20: SECTION 1.4 CLASSIC ISSUES IN FINAN
Page 23 and 24: equation (1.2) as SECTION 1.4 CLASS
Page 25 and 26: ate! In equations, if then SECTION
Page 33 and 34: SECTION 1.5 DISCOUNT FACTORS IN CON
Page 39 and 40: SECTION 1.6 PROBLEMS function with
Page 41 and 42: Chapter 2. Applying the basic model
Page 43: SECTION 2.2 GENERAL EQUILIBRIUM mig
Page 47 and 48: SECTION 2.3 CONSUMPTION-BASED MODEL
Page 49 and 50: SECTION 2.4 ALTERNATIVE ASSET PRICI
Page 51 and 52: SECTION 2.5 PROBLEMS Since the opti
Page 53 and 54: that function. From SECTION 2.5 PRO
Page 55 and 56: SECTION 3.2 RISK NEUTRAL PROBABILIT
Page 57 and 58: The discount factor prices the asse
Page 59 and 60: SECTION 3.4 RISK SHARING Asset pric
Page 61 and 62: State 2 Payoff SECTION 3.5 STATE DI
Page 63 and 64: SECTION 3.5 STATE DIAGRAM AND PRICE
Page 65 and 66: SECTION 4.1 LAW OF ONE PRICE AND EX
Page 67 and 68: SECTION 4.1 LAW OF ONE PRICE AND EX
Page 69 and 70: SECTION 4.2 NO-ARBITRAGE AND POSITI
Page 75 and 76: so SECTION 4.3 AN ALTERNATIVE FORMU
Page 77 and 78: Chapter 5. Mean-variance frontier a
Page 79 and 80: SECTION 5.1 EXPECTED RETURN -BETA R
Page 81 and 82: SECTION 5.2 MEAN-VARIANCE FRONTIER:
Page 83 and 84: SECTION 5.3 AN ORTHOGONAL CHARACTER
Page 85 and 86: SECTION 5.3 AN ORTHOGONAL CHARACTER
Page 87 and 88: SECTION 5.4 SPANNING THE MEAN-VARIA
Page 89 and 90: SECTION 5.5 A COMPILATION OF PROPER
Page 91 and 92: SECTION 5.5 A COMPILATION OF PROPER
Page 93 and 94: SECTION 5.6 MEAN-VARIANCE FRONTIERS
Page 95 and 96:
SECTION 5.6 MEAN-VARIANCE FRONTIERS
Page 97 and 98:
SECTION 5.7 PROBLEMS Hansen-Jaganna
Page 99 and 100:
SECTION 6.1 FROM DISCOUNT FACTORS T
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Asset Pricing John H. Cochrane June 12, 2000

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