Stock Prices Under Time-Varying Dividend Risk: An Exact Solution in an Infinite-Horizon General Equilibrium Model

The effects on asset prices of changes in risk are studied in a general equilibrium model in which the conditional risk evolves stochastically over time. The saving decisions of consumers take account of the fact that conditional risk is a serially correlated random variable. By restricting the specification of consumers' preferences and the stochastic specification of dividends, it is possible to obtain an exact solution for the prices of the aggregate stock and riskless one-period bonds. An increase in the conditional risk reduces the stock price if and only if the elasticity of marginal utility is less than one.