Exact Solutions for Expected Rates of Return Under Markov Regime Switching

Download or read book Exact Solutions for Expected Rates of Return Under Markov Regime Switching written by Andrew B. Abel and published by . This book was released on 2010 with total page 31 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper derives simple closed-form solutions for expected rates of return on stocks and riskless one-period bills under the assumption that shocks to the growth rates of consumption and dividends are generated by a Markov regime-switching process. These closed-form solutions are used to show that the Markov regime-switching process exacerbates the equity premium puzzle and the risk-free rate puzzle. Three empirical examples illustrate the magnitude of the effects of Markov regime switching on equilibrium expected returns.