Asset Pricing Model and Economic Activity of Firms

Abstract

This study derives the asset pricing model by introducing the economic activity of firms in the business cycle model which explores the expected returns of stocks and sheds light on the equity premium risk. Such a model follows the discrete-time optimization to come up with the asset pricing model that includes the economic activity variable. The result shows that the considerable factors affecting the rate of stock returns at a time are the rate of time preference, the firm investment at a time , the stock price, and the growth rate of private consumption at the time. Therefore, the economic activity of firms influences the expected returns on stock in a positive direction. In contrast, the growth rate of consumption has the opposite impact on the expected rate of stock returns.