Chapter 13 Asset Pricing . Introduction Chapter 8 showed how an equilibrium price system for an economy with complete markets model could be used to determine the price of any redundant asset. That approach allowed us to price any asset whose payoff could be synthesized | Chapter 13 Asset Pricing . Introduction Chapter 8 showed how an equilibrium price system for an economy with complete markets model could be used to determine the price of any redundant asset. That approach allowed us to price any asset whose payoff could be synthesized as a measurable function of the economy s state. We could use either the Arrow-Debreu time-0 prices or the prices of one-period Arrow securities to price redundant assets. We shall use this complete markets approach again later in this chapter. However we begin with another frequently used approach one that does not require the assumption that there are complete markets. This approach spells out fewer aspects of the economy and assumes fewer markets but nevertheless derives testable intertemporal restrictions on prices and returns of different assets and also across those prices and returns and consumption allocations. This approach uses only the Euler equations for a maximizing consumer and supplies stringent restrictions without specifying a complete general equilibrium model. In fact the approach imposes only a subset of the restrictions that would be imposed in a complete markets model. As we shall see even these restrictions have proved difficult to reconcile with the data the equity premium being a widely discussed example. Asset-pricing ideas have had diverse ramifications in macroeconomics. In this chapter we describe some of these ideas including the important Modigliani-Miller theorem asserting the irrelevance of firms asset structures. We describe a closely related kind of Ricardian equivalence theorem. We describe various ways of representing the equity premium puzzle and an idea of Mankiw 1986 that one day may help explain 1 See Duffie 1996 for a comprehensive treatment of discrete and continuous time asset pricing theories. See Campbell Lo and MacKinlay 1997 for a summary of recent work on empirical implementations. - 386 - Asset Euler equations 387 . Asset Euler equations
