Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices
AbstractWe propose an asset pricing model where preferences display generalized disappointment aversion (Routledge and Zin, 2009) and the endowment process involves long-run volatility risk. These preferences, which are embedded in the Epstein and Zin (1989) recursive utility framework, overweight disappointing results as compared to expected utility, and display relatively larger risk aversion for small gambles. With a Markov switching model for the endowment process, we derive closed-form solutions for all returns moments and predictability regressions. The model produces first and second moments of price-dividend ratios and asset returns and return predictability patterns in line with the data. Compared to Bansal and Yaron (2004), we generate: i) more predictability of excess returns by price-dividend ratios; ii) less predictability of consumption growth rates by price-dividend ratios. Differently from the Bansal and Yaron model, our results do not depend on a value of the elasticity of intertemporal substitution greater than one.
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Bibliographic InfoPaper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 636.
Date of creation: Jun 2010
Date of revision:
Publication status: Published in The Review of Financial Studies, vol.�24, n°1, 2011, p.�82-122.
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- Marco Bonomo & René Garcia & Nour Meddahi & Roméo Tédongap, 2011. "Generalized Disappointment Aversion, Long-run Volatility Risk, and Asset Prices," Review of Financial Studies, Society for Financial Studies, vol. 24(1), pages 82-122.
- Bonomo, Marco & Garcia, René & Meddahi, Nour & Tédongap, Roméo, 2010. "Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices," TSE Working Papers 10-187, Toulouse School of Economics (TSE).
- G1 - Financial Economics - - General Financial Markets
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
- C5 - Mathematical and Quantitative Methods - - Econometric Modeling
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