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Risk aversion, risk premia, and the labor margin with generalized recursive preferences

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  • Eric T. Swanson

Abstract

A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along either or both margins greatly alters the household’s attitudes toward risk, as shown by Swanson (2012). The present paper extends that work to the case of generalized recursive preferences, as in Epstein and Zin (1989) and Weil (1989), which are increasingly being used to bring macroeconomic models into closer agreement with basic asset pricing facts. Measures of risk aversion commonly used in the literature show no stable relationship to the equity premium in a standard RBC model, while the closed-form expressions derived in this paper match the equity premium closely. Thus, measuring risk aversion correctly is crucial for understanding asset prices in the model.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2012-17.

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Date of creation: 2012
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Handle: RePEc:fip:fedfwp:2012-17

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Keywords: Households - Economic aspects ; Risk assessment;

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  1. Martin Andreasen, 2012. "On the Effects of Rare Disasters and Uncertainty Shocks for Risk Premia in Non-Linear DSGE Models," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(3), pages 295-316, July.
  2. Francois Gourio, 2012. "Disaster Risk and Business Cycles," American Economic Review, American Economic Association, vol. 102(6), pages 2734-66, October.
  3. Francois Gourio, 2010. "Credit risk and Disaster risk," 2010 Meeting Papers 112, Society for Economic Dynamics.
  4. Eric Swanson & Gary Anderson & Andrew Levin, 2006. "Higher-order perturbation solutions to dynamic, discrete-time rational expectations models," Working Paper Series 2006-01, Federal Reserve Bank of San Francisco.
  5. Eric T. Swanson, 2012. "Risk Aversion and the Labor Margin in Dynamic Equilibrium Models," American Economic Review, American Economic Association, vol. 102(4), pages 1663-91, June.
  6. Marinacci, Massimo & Montrucchio, Luigi, 2010. "Unique solutions for stochastic recursive utilities," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1776-1804, September.
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