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Substitution, Risk Aversion, Taste Shocks and Equity Premia

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Abstract

This paper investigates the testable restrictions on the time-series behavior of equity premia implied by a representative agent model whose state- and time-non separable preferences are subject to taste shocks. The model nests state- and time-separable preferences with and without taste shocks as special cases. Empirically, the linearized Euler equations are estimated through Kalman filtering, allowing for conditional heteroscedasticity via a common factor GARCH process. With or without conditional heteroscedasticity, (i) the hypothesis that preferences are separable cannot be rejected, (ii) taste shocks influences are statistically significant, and (iii) taste shocks yield reasonable estimates of the coefficient of relative risk aversion. This last result occurs because taste shocks reproduce the large observed equity premium by shifting weight away from consumption risk in favor to taste risk. Cette étude vise à expliquer les primes associées aux titres financiers risqués (soit la différence entre les rendements que procurent les titres et les taux d'intérêt). Les restrictions testés sont dérivées à partir d'un modèle d'agent représentatif dont la fonction d'utilité est non séparable (par rapport au temps et aux états) et inclut des chocs de préférences. La méthodologie empirique consite à estimer les équations d'Euler linéarisées au moyen de filtres de Kalman et de processus GARCH. Les résultats indiquent d'abord que l'hypothèse de séparabilité n'est pas rejetée. Aussi, les chocs de préférence affectent significativement les primes et engendrent des estimés réalistes des coefficients d'aversion relative au risque. Ce dernier résultat implique que le risque de consommation est faible. Néanmoins, la présence de chocs de préférence permet de reproduire les fortes primes observées. Finalement, ces résultats ne sont pas altérés suite à l'inclusion d'hétéroscédasticité conditionnelle.

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Bibliographic Info

Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 39.

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Length: 27 pages
Date of creation: Jan 1996
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Handle: RePEc:cre:crefwp:39

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Keywords: conditional heteroskedasticity; consumption-based capital asset pricing model; Kalman filter; latent variables; state- and time-non-separable preferences; state- and time-separable preferences;

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Cited by:
  1. Michel Normandin, 2004. "Canadian and U.S. financial markets: testing the international integration hypothesis under time-varying conditional volatility," Canadian Journal of Economics, Canadian Economics Association, vol. 37(4), pages 1021-1041, November.
  2. Frédéric Gonand, 2014. "Fostering Renewables and Recycling a Carbon Tax: Joint Aggregate and Intergenerational Redistributive Effects," Working Papers 1408, Chaire Economie du Climat.
  3. Minh Ha-Duong & Nicolas Treich, 1999. "Recursive Intergenerational Utility in Global Climate Risk Modeling," CIRANO Working Papers 99s-40, CIRANO.
  4. Minh Ha-Duong & Nicolas Treich, 2004. "Risk aversion, intergenerational equity and climate change," Post-Print halshs-00000680, HAL.
  5. Traeger, Christian P, 2008. "Why uncertainty matters - discounting under intertemporal risk aversion and ambiguity," CUDARE Working Paper Series 1092R2, University of California at Berkeley, Department of Agricultural and Resource Economics and Policy, revised Jan 2012.
  6. Albuquerque, Rui & Eichenbaum, Martin & Rebelo, Sérgio, 2012. "Valuation Risk and Asset Pricing," CEPR Discussion Papers 9262, C.E.P.R. Discussion Papers.
  7. Michel Normandin, 1999. "The Integration of Financial Markets and the Conduct of Monetary Policies: The Case of Canada and the United States," Cahiers de recherche CREFE / CREFE Working Papers 67, CREFE, Université du Québec à Montréal.
  8. Michel Normandin, 2006. "The Effects of Monetary-Policy Shocks on Real Wages: A Multi-Country Investigation The Effects of Monetary-Policy Shocks on Real Wages: A Multi-Country Investigationv," Cahiers de recherche 06-04, HEC Montréal, Institut d'économie appliquée.
  9. Femminis, Gianluca, 2008. "Risk-aversion and the investment-uncertainty relationship: The role of capital depreciation," Journal of Economic Behavior & Organization, Elsevier, vol. 65(3-4), pages 585-591, March.
  10. Aude POMMERET & William T. SMITH, 2004. "Fertility, Volatility, and Growth," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 04.08, Université de Lausanne, Faculté des HEC, DEEP.
  11. Traeger, Christian P., 2011. "Interemporal Risk Aversion - or - Wouldn't it be Nice to Tell Whether Robinson Crusoe is Risk," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt67d581xt, Department of Agricultural & Resource Economics, UC Berkeley.
  12. COUTURE Stephane & REYNAUD Arnaud, 2006. "Multi-stand Forest Management Under a Climatic Risk: Do time and Risk Preferences Matter?," LERNA Working Papers 06.17.210, LERNA, University of Toulouse.
  13. Qiang Dai & Olesya V. Grishchenko, 2011. "An empirical investigation of consumption-based asset pricing models with stochastic habit formation," Finance and Economics Discussion Series 2011-47, Board of Governors of the Federal Reserve System (U.S.).
  14. Noah Kaufman, 2012. "The bias of integrated assessment models that ignore climate catastrophes," Climatic Change, Springer, vol. 110(3), pages 575-595, February.
  15. Howitt, Richard E. & Reynaud, Arnaud & Msangi, Siwa & Knapp, Keith C., 2002. "Calibrated Stochastic Dynamic Models for Resource Management," 2002 Annual meeting, July 28-31, Long Beach, CA 19620, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).

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