We provide an axiomatic model of preferences over atemporal risks that generalizes Gul (1991) A Theory of Disappointment Aversion' by allowing risk aversion to be first order' at locations in the state space that do not correspond to certainty. Since the lotteries being valued by an agent in an asset-pricing context are not typically local to certainty, our generalization, when embedded in a dynamic recursive utility model, has important quantitative implications for financial markets. We show that the state-price process, or asset-pricing kernel, in a Lucas-tree economy in which the representative agent has generalized disappointment aversion preferences is consistent with the pricing kernel that resolves the equity-premium puzzle. We also demonstrate that a small amount of conditional heteroskedasticity in the endowment-growth process is necessary to generate these favorable results. In addition, we show that risk aversion in our model can be both state-dependent and counter-cyclical, which empirical research has demonstrated is necessary for explaining observed asset-pricing behavior.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
10107.
Length: Date of creation: Nov 2003 Date of revision: Handle: RePEc:nbr:nberwo:10107
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Andrew Ang & Geert Bekaert & Jun Liu, 2000.
"Why Stocks May Disappoint,"
NBER Working Papers
7783, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
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Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Andrew Ang & Joseph Chen & Yuhang Xing, 2005.
"Downside Risk,"
NBER Working Papers
11824, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
David Backus & Bryan Routledge & Stanley Zin, 2004.
"Exotic Preferences for Macroeconomists,"
Working Papers
04-20, New York University, Leonard N. Stern School of Business, Department of Economics.
[Downloadable!]
David K. Backus & Bryan R. Routledge & Stanley E. Zin, 2005.
"Exotic Preferences for Macroeconomists,"
NBER Chapters,
in: NBER Macroeconomics Annual 2004, Volume 19, pages 319-414
National Bureau of Economic Research, Inc.
[Downloadable!]
David Backus, 2005.
"Recursive Preferences,"
Working Papers
05-19, New York University, Leonard N. Stern School of Business, Department of Economics.
[Downloadable!]