Idiosyncratic risk and volatility bounds , or can models with idiosyncratic risk solve the equity premium puzzle ?

@inproceedings{Lettau2001IdiosyncraticRA,
  title={Idiosyncratic risk and volatility bounds , or can models with idiosyncratic risk solve the equity premium puzzle ?},
  author={Martin Lettau},
  year={2001}
}
This paper uses Hansen and Jagannathan’s (1991) volatility bounds to evaluate models with idiosyncratic consumption risk. I show that idiosyncratic risk does not change the volatility bounds at all when consumers have CRRA preferences and the distribution of the idiosyncratic shock is independent of the aggregate state. Following Mankiw (1986), I then show that idiosyncratic risk can help to enter the bounds when idiosyncratic uncertainty depends on the aggregate state of the economy. Since… CONTINUE READING

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