State Dependence in Fundamentals and Preferences Explains Risk-Aversion Puzzle
AbstractThe authors examine the ability of economic models with regime shifts to rationalize and explain the risk-aversion and pricing-kernel puzzles put forward in Jackwerth (2000). They build an economy where investors' preferences or economic fundamentals are state-dependent, and simulate prices for a market index and European options on that index. Based on the original nonparametric methodology, the risk-aversion and pricing-kernel functions obtained across wealth states with these artificial data exhibit the same puzzles found with the actual data, but within each regime the puzzles disappear. This suggests that state dependence potentially explains the puzzles.
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 05-9.
Length: 33 pages
Date of creation: 2005
Date of revision:
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Financial markets; Market structure and pricing;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-04-09 (All new papers)
- NEP-BEC-2005-04-09 (Business Economics)
- NEP-CMP-2005-04-09 (Computational Economics)
- NEP-RMG-2005-04-09 (Risk Management)
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