Why Do Risk Premia Vary Over Time? A Theoretical Investigation Under Habit Formation
AbstractEmpirical evidence suggests that risk premia are higher at business cycle troughs than they are at peaks. Existing asset pricing theories ascribe moves in risk premia to changes in volatility or risk aversion. Nevertheless, in a simple general equilibrium model, risk premia can be procyclical even though the volatility of consumption is constant and despite a countercyclically varying risk aversion coefficient. We show that agents' expectations about future prospects also influence premium dynamics. In order to generate countercyclically varying premia, as found in the data, one requires a combination of hump-shaped consumption dynamics or highly persistent shocks and habits. Our results, thus, suggest that factors which help match activity data may also help along the asset pricing dimension.
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Bibliographic InfoArticle provided by Cambridge University Press in its journal Macroeconomic Dynamics.
Volume (Year): 16 (2012)
Issue (Month): S2 (September)
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Other versions of this item:
- De Paoli, Bianca & Zabczyk, Pawel, 2009. "Why do risk premia vary over time? A theoretical investigation under habit formation," Bank of England working papers 361, Bank of England.
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- Bianca De Paoli, Alasdair Scott, Olaf Weeken, 2007.
"Asset pricing implications for a New Keynesian model,"
Money Macro and Finance (MMF) Research Group Conference 2006
156, Money Macro and Finance Research Group.
- De Paoli, Bianca & Scott, Alasdair & Weeken, Olaf, 2010. "Asset pricing implications of a New Keynesian model," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 2056-2073, October.
- Bianca De Paoli & Alasdair Scott & Olaf Weeken, 2007. "Asset pricing implications of a New Keynesian model," Bank of England working papers 326, Bank of England.
- Bianca De Paoli & Alasdair Scott & Olaf Weeken, 2006. "Asset pricing implications of a New Keynesian model," Computing in Economics and Finance 2006 358, Society for Computational Economics.
- Hatcher, Michael, 2011. "Time-varying volatility, precautionary saving and monetary policy," Bank of England working papers 440, Bank of England.
- Fry, John, 2013. "Bubbles, shocks and elementary technical trading strategies," MPRA Paper 47052, University Library of Munich, Germany.
- Bianca De Paoli & Pawel Zabczyk, 2012.
"Cyclical Risk Aversion, Precautionary Saving and Monetary Policy,"
CEP Discussion Papers
dp1132, Centre for Economic Performance, LSE.
- Bianca De Paoli & Pawel Zabczyk, 2013. "Cyclical Risk Aversion, Precautionary Saving, and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(1), pages 1-36, 02.
- De Paoli, Bianca & Zabczyk, Pawel, 2011. "Cyclical risk aversion, precautionary saving and monetary policy," Bank of England working papers 418, Bank of England.
- De Paoli, Bianca & Sondergaard, Jens, 2009. "Foreign exchange rate risk in a small open economy," Bank of England working papers 365, Bank of England.
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