Risk Premia in General Equilibrium

This paper shows that non-linearities and non-normalities are important to generate empirically observed stylized facts of the risk premium. These key features can explain the equity premium puzzle and the time-varying behavior of the risk premium. We employ explicit solutions of dynamic stochastic general equilibrium (DSGE) models. It is shown that non-linearities in a prototype DSGE model can generate time-varying risk premia, while non-normalities can account for the observed risk-premium puzzle by drawing from the Barro-Rietz 'rare disaster hypothesis'.