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Asset Returns and State-Dependent Risk Preferences

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  • Gordon, Stephen
  • St-Amour, Pascal

Abstract

We propose a consumption-based capital asset pricing model in which the representative agent's preferences display state-dependent risk aversion. We obtain a valuation equation in which the vector of excess on equity includes both consumption risk as well as the risk associated with variations in preferences. We develop a simple model that can be estimated without specifying the functional form linking risk aversion with state variables. Our estimates are based on Markov chain Monte Carlo estimation of exact discrete-time parameterizations for linear diffusion processes. Since consumption risk is not forced to account for the entire risk premium, our results contrast sharply with estimates from models in which risk aversion is state-independent. We find that relaxing fixed risk preferences yields estimates for relative risk aversion that are (i) reasonable by usual standards, (ii) correlated with both consumption and returns and (iii) indicative of an additional preference risk of holding the asests.

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Bibliographic Info

Paper provided by CIRPEE in its series Cahiers de recherche with number 0316.

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Date of creation: 2003
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Handle: RePEc:lvl:lacicr:0316

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Related research

Keywords: Asset pricing models; Bayesian analysis; continuous-time econometric models; data augmentation; equity premium puzzle; Markov chain Monte Carlo; risk aversion; state-dependent preferences; wealth;

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Blog mentions

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  1. Welfare costs of the business cycle and the equity premium
    by Stephen in Worthwhile Canadian Initiative on 2006-12-15 19:09:36
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Cited by:
  1. Tim Bollerslev & Michael Gibson & Hao Zhou, 2007. "Dynamic Estimation of Volatility Risk Premia and Investor Risk Aversion from Option-Implied and Realized Volatilities," CREATES Research Papers 2007-16, School of Economics and Management, University of Aarhus.
  2. Ricardo M. Sousa, 2007. "Wealth Shocks and Risk Aversion," NIPE Working Papers 28/2007, NIPE - Universidade do Minho.
  3. Tim Bollerslev & Hao Zhou, 2006. "Expected stock returns and variance risk premia," Finance and Economics Discussion Series 2007-11, Board of Governors of the Federal Reserve System (U.S.).
  4. Bekaert, Geert & Engstrom, Eric & Grenadier, Steve, 2006. "Stock and Bond Returns with Moody Investors," CEPR Discussion Papers 5951, C.E.P.R. Discussion Papers.
  5. Angelo Melino & Alan X. Yang, 2003. "State Dependent Preferences Can Explain the Equity Premium Puzzle," Working Papers melino-03-01, University of Toronto, Department of Economics.
  6. Traian A. Pirvu & Huayue Zhang, 2012. "A Multi Period Equilibrium Pricing Model," Papers 1205.6193, arXiv.org.
  7. Lettau, Martin & Ludvigson, Sydney, 2005. "Euler Equation Errors," CEPR Discussion Papers 5245, C.E.P.R. Discussion Papers.
  8. Andrei Semenov, 2003. "High-Order Consumption Moments and Asset Pricing," Working Papers 2003_4, York University, Department of Economics, revised Jan 2005.
  9. Néstor Gándelman & Rubén Hernández-Murillo, 2011. "What do happiness and health satisfaction data tell us about relative risk aversion?," Working Papers 2011-039, Federal Reserve Bank of St. Louis.
  10. Andrei Semenov, 2004. "High-Order Consumption Moments and Asset Pricing," 2004 Meeting Papers 334, Society for Economic Dynamics.

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  1. Canadian Macro Study Group

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