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Counter-cyclical risk aversion

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  • Kim, Kun Ho

Abstract

The paper proposes a consistent estimator of time-varying risk aversion in consumption-based CAPM. Based on the Epstein–Zin–Weil (Epstein and Zin, 1989, 1991; Weil, 1989) recursive utility, we derive the Euler equation in which risk aversion is a non-parametric function of time. The proxy variable method is utilized to replace the unobserved return to aggregate wealth in the Euler equation. The estimation of risk aversion is carried out based on a two-stage local-linear regression method. Given the estimate, we investigate the conventional wisdom in economics that risk aversion is counter-cyclical. The empirical results strongly support the counter-cyclicality of the risk aversion parameter.

Suggested Citation

  • Kim, Kun Ho, 2014. "Counter-cyclical risk aversion," Journal of Empirical Finance, Elsevier, vol. 29(C), pages 384-401.
    • Handle: RePEc:eee:empfin:v:29:y:2014:i:c:p:384-401
    DOI: 10.1016/j.jempfin.2014.09.005
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    More about this item

    Keywords

    Consumption-based capital asset pricing model; Time-varying risk aversion; Two-stage local linear regression; Consistency; Local-stationarity; Counter-cyclicality;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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