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Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices

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  • Bonomo, Marco
  • Garcia, René
  • Meddahi, Nour
  • Tédongap, Roméo

Abstract

We 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 Info

Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 636.

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Date of creation: Jun 2010
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Publication status: Published in The Review of Financial Studies, vol.�24, n°1, 2011, p.�82-122.
Handle: RePEc:ide:wpaper:23192

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Cited by:
  1. Monfort, Alain & Pegoraro, Fulvio, 2012. "Asset pricing with Second-Order Esscher Transforms," Journal of Banking & Finance, Elsevier, vol. 36(6), pages 1678-1687.
  2. Ang, Andrew & Timmermann, Allan G, 2011. "Regime Changes and Financial Markets," CEPR Discussion Papers 8480, C.E.P.R. Discussion Papers.
  3. Stanislav Khrapov, 2012. "Risk Premia: Short and Long-term," Working Papers w0169, Center for Economic and Financial Research (CEFIR).
  4. David le Bris & William N. Goetzmann & Sébastien Pouget, 2014. "Testing Asset Pricing Theory on Six Hundred Years of Stock Returns: Prices and Dividends for the Bazacle Company from 1372 to 1946," NBER Working Papers 20199, National Bureau of Economic Research, Inc.
  5. Jianjian Jin, 2013. "Jump-Diffusion Long-Run Risks Models, Variance Risk Premium and Volatility Dynamics," Working Papers 13-12, Bank of Canada.
  6. Pagel, Michaela, 2012. "Expectations-Based Reference-Dependent Preferences and Asset Pricing," MPRA Paper 47933, University Library of Munich, Germany.
  7. Emi Nakamura & Dmitriy Sergeyev & Jón Steinsson, 2012. "Growth-Rate and Uncertainty Shocks in Consumption: Cross-Country Evidence," NBER Working Papers 18128, National Bureau of Economic Research, Inc.
  8. Bakshi, Gurdip & Chabi-Yo, Fousseni, 2011. "Variance Bounds on the Permanent and Transitory Components of Stochastic Discount Factors," Working Paper Series 2011-11, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  9. Cheng, Ai-Ru & Jahan-Parvar, Mohammad R., 2014. "Risk–return trade-off in the pacific basin equity markets," Emerging Markets Review, Elsevier, vol. 18(C), pages 123-140.

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