Chapter 12.2: General asset pricing mode」 Fan longzhen July. 2003
Chapter 12.2: General asset pricing model Fan Longzhen July, 2003
Consumption-Based model and Basic Pricing model Basic question to decide for an investor ·(1) how much to save; (2) how much to consume ()what portfolio of assets to hold Pricing equation come from the first order condition for this decision
Consumption-Based Model and Basic Pricing Model • Basic question to decide for an investor: • (1) how much to save; • (2) how much to consume; • (3)what portfolio of assets to hold. • Pricing equation come from the first order condition for this decision
Marginal utility and its indicator Marginal utility, not consumption, is the fundamental measure of how you feel Theory of asset pricing is about how to go from marginal utility to observable indicators Consumption is an indicator of marginal utility When consumption is low, marginal utility is high a large index may be an indicator. a large index goes down, the wealth of investors goes down consumption goes down, marginal utility becomes
Marginal utility and its indicator • Marginal utility, not consumption, is the fundamental ,measure of how you feel. • Theory of asset pricing is about how to go from marginal utility to observable indicators. • Consumption is an indicator of marginal utility. When consumption is low, marginal utility is high. • A large index may be an indicator. A large index goes down, the wealth of investors goes down, consumption goes down, marginal utility becomes high
Basic Pricing equation Basic pricing problem is to price stream of any uncertainty cash flows; Any asset, for example, a stock, with price p and dividend d, next period. The payoff next period is xu 1 =p+d What is value of the payoff today for a typical investor We need a model to model typical investors utility happiness)of consumption +1=0(c)+ BE JU(C DI The utility functions may be a power utility form
Basic Pricing Equation • Basic pricing problem is to price stream of any uncertainty cash flows; • Any asset, for example, a stock, with price and dividend next period. The payoff next period is • What is value of the payoff today for a typical investor. • We need a model to model typical investor’s utility ( happiness) of consumption • • The utility functions may be a power utility form ( , ) ( ) [ ( ) ] t t+1 = t + t t+1 U c c U c βE U c γ γ − − = 1 1 1 ( )t t U c c t+1 p dt+1 t+1 = pt+1 + dt+1 x
Utility Utility function satisfy conditions (1)desire for more consumption, increasing function; (2)marginal utility is decreasing: ()impatience for time: B--subjective discount factor (4)aversion for risk curvature of utility function
utility • Utility function satisfy conditions: • (1) desire for more consumption, increasing function; • (2)marginal utility is decreasing; • (3) impatience for time: β--subjective discount factor; • (4) aversion for risk:curvature of utility function