On the Consequences of State Dependent Preferences for the Pricing of Financial Assets
AbstractThis Paper introduces state dependent utility into the standard Mehra and Prescott (1985) economy by allowing the representative agent’s coefficient of relative risk aversion to vary with the underlying economy’s growth rate. Existence of equilibrium is proved and its asymptotic properties analysed. This generalization leads to level dependent marginal rates of substitution, a property that sharply distinguishes this model from the standard construct. For very low coefficients of relative risk aversion, the equilibrium risk free and risky security returns are demonstrated to have volatilities and an associated equity premium that substantially exceed what is found in the data. This provides a contrasting perspective on the classic ‘equity premium puzzle.’
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3697.
Date of creation: Jan 2003
Date of revision:
Contact details of provider:
Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
Other versions of this item:
- Danthine, Jean-Pierre & Donaldson, John B. & Giannikos, Christos & Guirguis, Hany, 2004. "On the consequences of state dependent preferences for the pricing of financial assets," Finance Research Letters, Elsevier, vol. 1(3), pages 143-153, September.
- Jean-Pierre Danthine & John B. Donaldson & Christos Giannikos & Hany Guirguis, 2002. "On the Consequences of State Dependent Preferences for the Pricing of Financial Assets," Cahiers de Recherches Economiques du DÃ©partement d'EconomÃ©trie et d'Economie politique (DEEP) 02.17, Université de Lausanne, Faculté des HEC, DEEP.
- Jean-Pierre Danthine & John B. Donaldson & Christos Giannikos & Hany Guirguis, 2004. "On the Consequences of State Dependent Preferences for the Pricing of Financial Assets," FAME Research Paper Series rp73, International Center for Financial Asset Management and Engineering.
- D91 - Microeconomics - - Intertemporal Choice - - - Intertemporal Household Choice; Life Cycle Models and Saving
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-04-09 (All new papers)
- NEP-CFN-2003-04-09 (Corporate Finance)
- NEP-RMG-2003-04-09 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Constantinides, George M, 1990.
"Habit Formation: A Resolution of the Equity Premium Puzzle,"
Journal of Political Economy,
University of Chicago Press, vol. 98(3), pages 519-43, June.
- G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
- Bosch-Domenech, Antoni & Silvestre, Joaquim, 1999.
"Does risk aversion or attraction depend on income? An experiment,"
Elsevier, vol. 65(3), pages 265-273, December.
- Antoni Bosch-Domènech & Joaquim Silvestre, 1999. "Does risk aversion or attraction depend on income? An experiment," Economics Working Papers 361, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 1999.
- Antonio Falato, 2003. "Happiness Maintenance and Asset Prices," Finance 0310003, EconWPA.
- Mehra, Rajnish & Prescott, Edward C., 1985.
"The equity premium: A puzzle,"
Journal of Monetary Economics,
Elsevier, vol. 15(2), pages 145-161, March.
- Phillippe Weil, 1997.
"The Equity Premium Puzzle and the Risk-Free Rate Puzzle,"
Levine's Working Paper Archive
1833, David K. Levine.
- Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
- Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
- 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.
- Cochrane, John H. & Campbell, John, 1999.
"By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior,"
3119444, Harvard University Department of Economics.
- John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
- John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
- John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
- Isen, Alice M. & Geva, Nehemia, 1987. "The influence of positive affect on acceptable level of risk: The person with a large canoe has a large worry," Organizational Behavior and Human Decision Processes, Elsevier, vol. 39(2), pages 145-154, April.
- Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
- Angelo Melino & Alan X. Yang, 2003.
"State Dependent Preferences Can Explain the Equity Premium Puzzle,"
melino-03-01, University of Toronto, Department of Economics.
- 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.
- Nygren, Thomas E. & Isen, Alice M. & Taylor, Pamela J. & Dulin, Jessica, 1996. "The Influence of Positive Affect on the Decision Rule in Risk Situations: Focus on Outcome (and Especially Avoidance of Loss) Rather Than Probability," Organizational Behavior and Human Decision Processes, Elsevier, vol. 66(1), pages 59-72, April.
- Rajnish Mehra & Raaj Sah, 1999.
"Can Small Fluctuations in Investors' Subjective Preferences Induce Large Volatility in Equity Prices?,"
9917, Harris School of Public Policy Studies, University of Chicago.
- Mehra, Rajnish & Sah, Raaj, 2002. "Mood fluctuations, projection bias, and volatility of equity prices," Journal of Economic Dynamics and Control, Elsevier, vol. 26(5), pages 869-887, May.
- Miroslav Misina, 2005. "Risk Perceptions and Attitudes," Working Papers 05-17, Bank of Canada.
- Miroslav Misina, 2003.
"What Does the Risk-Appetite Index Measure?,"
03-23, Bank of Canada.
- Felix Kubler & Karl Schmedders, 2010.
"Non-parametric counterfactual analysis in dynamic general equilibrium,"
Springer, vol. 45(1), pages 181-200, October.
- Felix Kubler & Karl Schmedders, 2007. "Non-parametric counterfactual analysis in dynamic general equilibrium," PIER Working Paper Archive 07-027, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
- Felix KUBLER & Karl SCHMEDDERS, . "Non-parametric counterfactual analysis in dynamic general equilibrium," Swiss Finance Institute Research Paper Series 09-05, Swiss Finance Institute.
- Dominique Pepin, 2011. "Instabilité des comportements et cycles financiers : une relecture dans un cadre rationnel avec préférences endogènes," Working Papers hal-00960012, HAL.
- Jaime A. Londo\~no, 2006. "State Dependent Utility," Papers math/0603316, arXiv.org.
- Falato, Antonio, 2009. "Happiness maintenance and asset prices," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1247-1262, June.
- John Donaldson & Rajnish Mehra, 2007. "Risk Based Explanations of the Equity Premium," NBER Working Papers 13220, National Bureau of Economic Research, Inc.
- Antonio Falato, 2008. "Happiness maintenance and asset prices," Finance and Economics Discussion Series 2008-19, Board of Governors of the Federal Reserve System (U.S.).
- Pascal St-Amour, 2004. "Ratchet vs Blasé Investors and Asset Markets," CIRANO Working Papers 2004s-11, CIRANO.
- Kraus, Alan & Sagi, Jacob S., 2006. "Asset pricing with unforeseen contingencies," Journal of Financial Economics, Elsevier, vol. 82(2), pages 417-453, November.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.