| Asset pricing is one of the core tasks of the finance research. Consumption CAPM built up a connection between asset pricing theory and the general equilibrium Economics. However,"the equity premium puzzle" poses a challenge to the explanatory power of the model. Stochastic discount factor of utility function and the risk premium has become a commonly used method to explain the risk premium from the perspective of investors’ preferences.In addition to the preferences of the investors themselves, the macroeconomic factors have important implications for the prices of risky assets. Putting the macroeconomic factors into the behavior of the micro-agent has aroused general interest of financial studies.In the continuous-time model based on the inflation illusion added to the investor utility function which contains the wealth effect, the investor cannot tell the differences between real and nominal consumption and real wealth and nominal wealth effect. By solving the model, we get the investor’s consumption and investment choice, and the stochastic discount factor and the risk premium of the risk of asset pricing.The main contents include the following aspects:(1) From the perspective of utility maximization, the investor’s current real consumption will increase with the expected inflation, because high expected inflation makes the investor perceive a higher growth rate of expected nominal wealth, due to confuse the real wealth and the nominal wealth, i.e. the investor mistakenly believes that he will be richer, thereby increasing the current real consumption.(2) The risk premium needs to include compensation for these three risk factors, and this compensation claim increases with the investors’ degree of concern for the consumption and wealth. In the case of the inflation risk, if the risk asset is able to hedge against inflation, the investor will require a lower risk premium; if not, the investor will require a higher risk premium.(3) Empirical analysis shows that the equity premium puzzle of China’s stock market is not as obvious as U.S. market. The wealth effect in the pricing model has some explanatory power for the U.S. market and Chinese markets. Without the wealth effect, inflation illusion on consumption shows poor explanatory power on Chinese market, because we cannot find an appropriate level of inflation illusion in this form that will enable the level of relative risk aversion to be in a reasonable range. However, explanatory power of this model on the U.S. market increases with the increase of the degree of inflation illusion. The model we created in this paper which joins the inflation illusion in wealth, makes a very good explanation to the equity premium puzzle of China’s stock market. |
