Extrapolative Asset Pricing

35 Pages Posted: 14 Feb 2018 Last revised: 2 Nov 2020

See all articles by Kai Li

Kai Li

Macquarie Business School, Macquarie University

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management

Date Written: October 31, 2020

Abstract

We study asset pricing implications of return extrapolation in a Lucas economy. We find that the effect of extrapolation is mainly on short rates rather than risk premia, time variation in expected returns is mainly driven by time-varying short rates, and return volatility can be lower than consumption volatility. Therefore, return extrapolation documented in survey expectations literature does not help resolve asset pricing puzzles. Our findings are different from Barberis, Greenwood, Jin and Shleifer (2015) who study price extrapolation and assume an exogenous short rate. Our results highlight the subtle differences of price extrapolation and return extrapolation.

Keywords: Extrapolation, riskless rate puzzle, equity premium puzzle, excess volatility, market clearing, momentum, return predictability

JEL Classification: G12

Suggested Citation

Li, Kai and Liu, Jun, Extrapolative Asset Pricing (October 31, 2020). Available at SSRN: https://ssrn.com/abstract=3116643 or http://dx.doi.org/10.2139/ssrn.3116643

Kai Li (Contact Author)

Macquarie Business School, Macquarie University ( email )

Level 6 4 Eastern Road, Macquarie University
North Ryde NSW 2109
Sydney, NSW 99999
Australia
435473800 (Phone)

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858.534.2022 (Phone)
5858.534.0745 (Fax)

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