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A Revealed Preference Analysis of Asset Pricing under Recursive Utility

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  • Epstein, Larry G
  • Melino, Angelo

Abstract

This paper considers a representative agent model of asset prices based on a recursive utility specification. A constant elasticity of intertemporal substitution is assumed but the risk-preference component of utility is restricted only by qualitative, nonparametric regularity conditions. A principal contribution is to determine the exhaustive implications of this semiparametric recursive utility model for the one-step ahead joint probability distribution for consumption growth and asset returns. It is also shown, in contrast to the claims of previous studies, that the generalization from expected utility to recursive utility contributes substantially to the resolution of the equity premium puzzle. Copyright 1995 by The Review of Economic Studies Limited.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Review of Economic Studies.

Volume (Year): 62 (1995)
Issue (Month): 4 (October)
Pages: 597-618

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Handle: RePEc:bla:restud:v:62:y:1995:i:4:p:597-618

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References

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  1. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  2. Hadar, Josef & Russell, William R, 1969. "Rules for Ordering Uncertain Prospects," American Economic Review, American Economic Association, vol. 59(1), pages 25-34, March.
  3. Obstfeld, Maurice, 1994. "Evaluating risky consumption paths: The role of intertemporal substitutability," European Economic Review, Elsevier, vol. 38(7), pages 1471-1486, August.
  4. Machina, Mark J, 1987. "Choice under Uncertainty: Problems Solved and Unsolved," Journal of Economic Perspectives, American Economic Association, vol. 1(1), pages 121-54, Summer.
  5. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  6. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  7. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of security market data for models of dynamic economies," Discussion Paper / Institute for Empirical Macroeconomics 29, Federal Reserve Bank of Minneapolis.
  8. Shmuel Kandel & Robert F. Stambaugh, . "Modeling Expected Stock Returns for Long and Short Horizons," Rodney L. White Center for Financial Research Working Papers 42-88, Wharton School Rodney L. White Center for Financial Research.
  9. Heaton, John, 1993. "The Interaction between Time-Nonseparable Preferences and Time Aggregation," Econometrica, Econometric Society, vol. 61(2), pages 353-85, March.
  10. Marco Antonio Bonomo & Rene Garcia, 1993. "Disappointment aversion as a solution to the equity premium and the risk-free rate puzzles," Textos para discussão 308, Department of Economics PUC-Rio (Brazil).
  11. Gallant, Ronald & Tauchen, George, 1989. "Seminonparametric Estimation of Conditionally Constrained Heterogeneous Processes: Asset Pricing Applications," Econometrica, Econometric Society, vol. 57(5), pages 1091-1120, September.
  12. Green, Richard C. & Srivastava, Sanjay, 1986. "Expected utility maximization and demand behavior," Journal of Economic Theory, Elsevier, vol. 38(2), pages 313-323, April.
  13. Hanoch, G & Levy, Haim, 1969. "The Efficiency Analysis of Choices Involving Risk," Review of Economic Studies, Wiley Blackwell, vol. 36(107), pages 335-46, July.
  14. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March.
  15. Green, Edward J & Osband, Kent, 1991. "A Revealed Preference Theory for Expected Utility," Review of Economic Studies, Wiley Blackwell, vol. 58(4), pages 677-96, July.
  16. Dybvig, Philip H & Ross, Stephen A, 1982. "Portfolio Efficient Sets," Econometrica, Econometric Society, vol. 50(6), pages 1525-46, November.
  17. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
  18. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  19. Wang Susheng, 1993. "The Local Recoverability of Risk Aversion and Intertemporal Substitution," Journal of Economic Theory, Elsevier, vol. 59(2), pages 333-363, April.
  20. Epstein, Larry G. & Zin, Stanley E., 2001. "The independence axiom and asset returns," Journal of Empirical Finance, Elsevier, vol. 8(5), pages 537-572, December.
  21. Camerer, Colin F, 1989. " An Experimental Test of Several Generalized Utility Theories," Journal of Risk and Uncertainty, Springer, vol. 2(1), pages 61-104, April.
  22. John H. Cochrane & Lars Peter Hansen, 1992. "Asset Pricing Explorations for Macroeconomics," NBER Working Papers 4088, National Bureau of Economic Research, Inc.
  23. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 29-42, February.
  24. Epstein, Larry G. & Zin, Stanley E., 1990. "'First-order' risk aversion and the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 26(3), pages 387-407, December.
  25. Kandel, Shmuel & Stambaugh, Robert F., 1991. "Asset returns and intertemporal preferences," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 39-71, February.
  26. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  27. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
  28. S. Grossman & R. Shiller, . "The Determinants of the Variability of Stock Market Price," Rodney L. White Center for Financial Research Working Papers 18-80, Wharton School Rodney L. White Center for Financial Research.
  29. Border, Kim C., 1992. "Revealed preference, stochastic dominance, and the expected utility hypothesis," Journal of Economic Theory, Elsevier, vol. 56(1), pages 20-42, February.
  30. Fishburn, Peter C., 1975. "Separation theorems and expected utilities," Journal of Economic Theory, Elsevier, vol. 11(1), pages 16-34, August.
  31. Epstein, Larry G., 1988. "Risk aversion and asset prices," Journal of Monetary Economics, Elsevier, vol. 22(2), pages 179-192, September.
  32. Starmer, Chris, 1992. "Testing New Theories of Choice under Uncertainty Using the Common Consequence Effect," Review of Economic Studies, Wiley Blackwell, vol. 59(4), pages 813-30, October.
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Citations

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Cited by:
  1. Angelo Melino & Alan X. Yang, 2003. "State Dependent Preferences Can Explain the Equity Premium Puzzle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 806-830, October.
  2. Angelo Melino, 2010. "Measuring the cost of economic fluctuations with preferences that rationalize the equity premium," Canadian Journal of Economics, Canadian Economics Association, vol. 43(2), pages 405-422, May.
  3. Giordani, Paolo & Soderlind, Paul, 2004. "Solution of macromodels with Hansen-Sargent robust policies: some extensions," Journal of Economic Dynamics and Control, Elsevier, vol. 28(12), pages 2367-2397, December.
  4. Lars Peter Hansen & Thomas J. Sargent, 2001. "Acknowledging Misspecification in Macroeconomic Theory," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(3), pages 519-535, July.
  5. Marinacci, Massimo & Montrucchio, Luigi, 2010. "Unique solutions for stochastic recursive utilities," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1776-1804, September.

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