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"Rather than saying "MPK determines r", it would be more true to say "MRScc determines r, which determines the prices of capital goods". And the only thing wrong with saying that is that is that MRScc is not a fixed number, but depends on the expected growth rate of consumption, which in turn depends on our ability to divert resources to producing extra capital goods instead of consumption goods, and the productivity of those extra capital goods." You just captured the essence of consumption based asset pricing theory! Also, of interest is idea of stochastic discount factors: John Cochranne has an interesting Presidential address that focuses on it. You can find it here-
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Small world indeed JW Mason! Interesting points though- will have to think more about them. Meanwhile, a couple of points that quickly come to mind: 1. Leijonhufvud's argument about risk being symmetrical- takes us into the world of modeling terms of trade between a lender and a borrower. I would rather argue that distribution of risk between borrower and lender depends on their relative bargaining power. In short you might have to carefully model the market structure of financial intermediation. But even if we assume that people have claims to future income and they don't care about them then presence of secondary markets should solve the problem. 2. Consumers have finite horizon or do not care about bequests is more of an assumption. Also, it might be more relevant to talk about degree of impatience rather than finiteness of the horizon. Given this, one would like to see what are the implications of households with different consumption horizons or different patience levels for asset prices. May be the consumption based CAPM could deliver some insights.
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Fascinating discussion! I am currently teaching my students about rate of return equality in the world with money and capital and hence this post and discussions come at the right time. At the risk of redundancy let me add my 5 cents. In a world of perfect substitutability between capital and money, the returns would be equal. But along with uncertainly and risk aversion, you will have to pay someone to hold capital instead of money and that could explain the rate of return dominance puzzle. Another way of looking at it is suggested by Lagos and Rocheteau (2008). They start with an economy where money and capital are both valued. However, if for some reason "when the socially efficient stock of capital is too low to provide the liquidity agents need, they over accumulate productive assets to use as media of exchange". The situation could be easily reversed in inflationary times or if landlessness is rampant. This is easily imaginable in an agrarian setting like in India where cattle stock competes with money as a means to ensure future consumption as well as insurance. So cattle provides stream of consumption goods plus another avenue for ensuring consumption in uncertain times. In addition you can ensure that capital grows (except land perhaps) and hence have some control over capital accumulation. Given this and considering risk aversion, an asset portfolio of a typical agent will always feature a positive amount of both capital and money but capital will earn a positive and higher rate of return than money.
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Nov 13, 2013