THE INTERACTION BETWEEN NONEXPECTED UTILITY AND ASYMMETRIC MARKET FUNDAMENTALS

This paper studies a nonexpected utility, general equilibrium asset pr icing model in which market fundamentals follow a bivariate Markov swi tching process. The results show that nonexpected utility is capable o f exactly matching the means of the risk-free rate and the risk premiu m. Asymmetric market fundamentals are capable of generating a negative sample correlation between the risk-free rate and the risk premium. M oreover, an equilibrium asset pricing model endowed with asymmetric ma rket fundamentals is consistent with all five first and second moments of the risk-free rate and the risk premium in the U.S. data.