GENERAL EQUILIBRIUM WITH CONSTANT RELATIVE RISK AVERSION AND VASICEK INTEREST RATES1

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  • 1

    We are grateful to an associate editor and a referee for many helpful suggestions. A previous version was presented at the Econometric Society Meetings (as part of the ASSA) in January 1995 Existing errors are our sole responsibility

Abstract

We consider a pure exchange economy consisting of a single risky asset whose dividend drift rate is modeled as an Omstein-Uhlenbeck process, and a representative agent with power-utility who, in equilibrium, consumes the dividend paid by the risky asset. Endogenously determined interest rates are found to be of the Vasicek (1977) type the mean and variance of the equilibrium stock price are stochastic and have mean-reverting components A closed-form solution for a standard call option is determined for the case of log-utility. Equilibrium values have interesting implications for the equity premium puzzle observed by Mehra and Prescott (1985)

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