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COPYRIGHT NOTICE: Michael Wickens: Macroeconomic Theory is published by Princeton University Press and copyrighted, © 2008, by Princeton University Press. All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher, except for reading and browsing via the World Wide Web. Users are not permitted to mount this file on any network servers. Follow links for Class Use and other Permissions. For more information send email to: permissions@pupress.princeton.edu 10 Asset Pricing and Macroeconomics 10.1 Introduction Assets—physical, human, and financial capital—play a crucial role in macro­ economics. They are required for production and for generating income, and they are central to the intertemporal allocation of resources through the pro­ cesses of saving, lending, and borrowing. In this chapter we focus on how finan­ cial assets are priced in general equilibrium. In chapter 11 we apply these the­ ories to three financial assets: bonds, equity, and foreign exchange. Each asset has specific features that require the theories to be applied separately. We began our macroeconomic analysis by discussing the decision about whether to consume today or in the future. This gave us our theories of physical capital accumulation and savings. We argued that people plan their consump­ tion both for today and for the rest of their lives with the aim of maintaining their standard of living even though income may vary through time. During periods when income is low—in retirement or in periods of unemployment, for example—their standard of living would fall unless they had saved some of their income and could draw on this. In order to consume more in the future, people must cons