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Asset Returns and State-Dependent Risk Preferences

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  • Stephen Gordon

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  • Pascal St-Amour

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Abstract

We propose a consumption-based capital asset pricing model in which the representative agent's preferences display state-dependent risk aversion. We obtain a valuation equation in which the vector of excess returns on equity includes both consumption risk as well as the risk associated with variations in preferences. We develop a simple model that can be estimated without specifying the functional form linking risk aversion with state variables. Our estimates are based on Markov chain Monte Carlo estimation of exact discrete-time parameterizations for linear diffusion processes. Since consumption risk is not forced to account for the entire risk premium, our results contrast sharply with estimates from models in which risk aversion is state-independent. We find that relaxing fixed risk preferences yields estimates for relative risk aversion that are (i) reasonable by usual standards, (ii) correlated with both consumption and returns and (iii) indicative of an additional preference risk of holding the assets. Nous suggérons un modèle d'équilibre de prix des actifs où les préférences de l'agent représentatif sont caractérisées par une aversion contingente au risque. Nous obtenons une équation de valorisation où la prime de risque dépend du risque de préférences en plus du risque de consommation habituel. Nous développons une application empirique qui ne nécessite pas une forme fonctionnelle reliant l'aversion non-observable à des variables économiques observables. Nos estimations sont basées sur une estimation en chaîne markovienne de Monte-Carlo pour des vraisemblances exactes de processus linéaires de diffusion appliquées aux données en temps discret. Puisque le risque de consommation n'a plus à justifier seul la forte prime de risque observée sur les fonds propres, nos estimations contrastent fortement avec celles obtenues dans le cas standard où l'aversion au risque est constante. En particulier, nous trouvons des estimés de l'aversion au risque qui sont (i) de niveau raisonnable, (ii) corrélés avec la consommation et les rendements et (iii) cohérents avec un risque additionnel de détention d'actifs.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2003s-09.

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Date of creation: 01 Apr 2003
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Handle: RePEc:cir:cirwor:2003s-09

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Keywords: Asset Pricing Models; Bayesian Analysis; Continuous-time Econometric Models; Data Augmentation; Equity Premium Puzzle; Markov Chain Monte Carlo; Risk Aversion; State-Dependent Preferences; Wealth; Modèles de prix des actifs; analyse bayesienne; modèles économétriques en temps continu; augmentation de données; énigme de la prime de risque; chaîne markovienne de Monte Carlo; aversion au risque; préférences contingentes; richesse;

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  1. Welfare costs of the business cycle and the equity premium
    by Stephen in Worthwhile Canadian Initiative on 2006-12-15 19:09:36
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Cited by:
  1. Tim Bollerslev & Michael Gibson & Hao Zhou, 2007. "Dynamic Estimation of Volatility Risk Premia and Investor Risk Aversion from Option-Implied and Realized Volatilities," CREATES Research Papers 2007-16, School of Economics and Management, University of Aarhus.
  2. Ricardo M. Sousa, 2007. "Wealth Shocks and Risk Aversion," NIPE Working Papers 28/2007, NIPE - Universidade do Minho.
  3. Tim Bollerslev & Hao Zhou, 2006. "Expected stock returns and variance risk premia," Finance and Economics Discussion Series 2007-11, Board of Governors of the Federal Reserve System (U.S.).
  4. Bekaert, Geert & Engstrom, Eric & Grenadier, Steve, 2006. "Stock and Bond Returns with Moody Investors," CEPR Discussion Papers 5951, C.E.P.R. Discussion Papers.
  5. Angelo Melino & Alan X. Yang, 2003. "State Dependent Preferences Can Explain the Equity Premium Puzzle," Working Papers melino-03-01, University of Toronto, Department of Economics.
  6. Traian A. Pirvu & Huayue Zhang, 2012. "A Multi Period Equilibrium Pricing Model," Papers 1205.6193, arXiv.org.
  7. Lettau, Martin & Ludvigson, Sydney, 2005. "Euler Equation Errors," CEPR Discussion Papers 5245, C.E.P.R. Discussion Papers.
  8. Andrei Semenov, 2003. "High-Order Consumption Moments and Asset Pricing," Working Papers 2003_4, York University, Department of Economics, revised Jan 2005.
  9. Néstor Gándelman & Rubén Hernández-Murillo, 2011. "What do happiness and health satisfaction data tell us about relative risk aversion?," Working Papers 2011-039, Federal Reserve Bank of St. Louis.
  10. Andrei Semenov, 2004. "High-Order Consumption Moments and Asset Pricing," 2004 Meeting Papers 334, Society for Economic Dynamics.

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