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Risk Aversion and Determinants of Stock Market Behavior

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  • Robert S. Pindyck

Abstract

A simple model of equity pricing is developed to address two related questions. First, to what extent can unanticipated changes in such"fundamental" variables as profitability, real interest rates, inflation, and the variance of returns account for the observed behavior of the stockmarket? Second, how risk averse are investors in the aggregate?We find that the pretax profit rate and the variance of returns are both significant explanators of the market, and interest rates somewhat less so. Estimates of the index of relative risk aversion are obtained that put that parameter in the range of 3 to 4.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1921.

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Date of creation: May 1986
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Publication status: published as Review of Economics and Statistics, vol. 70, no. 2, pp. 183-190, May 1988.
Handle: RePEc:nbr:nberwo:1921

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  1. Fischer, Stanley & Merton, Robert C., 1984. "Macroeconomics and finance: The role of the stock market," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 21(1), pages 57-108, January.
  2. Pindyck, Robert S, 1984. "Risk, Inflation, and the Stock Market," American Economic Review, American Economic Association, vol. 74(3), pages 335-51, June.
  3. Martin Feldstein, 1983. "Inflation, Tax Rules, and the Stock Market," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 199-220 National Bureau of Economic Research, Inc.
  4. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
  5. S. Grossman & R. Shiller, . "The Determinants of the Variability of Stock Market Price," Rodney L. White Center for Financial Research Working Papers 18-80, Wharton School Rodney L. White Center for Financial Research.
  6. N. Gregory Mankiw & Julio J. Rotemberg & Lawrence H. Summers, 1982. "Intertemporal Substitution in Macroeconomics," NBER Working Papers 0898, National Bureau of Economic Research, Inc.
  7. Martin Feldstein, 1983. "Inflation and the Stock Market," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 186-198 National Bureau of Economic Research, Inc.
  8. Officer, R R, 1973. "The Variability of the Market Factor of the New York Stock Exchange," The Journal of Business, University of Chicago Press, vol. 46(3), pages 434-53, July.
  9. Zvi Bodie & Alex Kane & Robert L. McDonald, 1983. "Why Are Real Interest Rates So High?," NBER Working Papers 1141, National Bureau of Economic Research, Inc.
  10. Poterba, James M & Summers, Lawrence H, 1986. "The Persistence of Volatility and Stock Market Fluctuations," American Economic Review, American Economic Association, vol. 76(5), pages 1142-51, December.
  11. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
  12. Jeffrey A. Frankel, 1983. "A Test of Portfolio Crowding-Out and Related Issues in Finance," NBER Working Papers 1205, National Bureau of Economic Research, Inc.
  13. Feldstein, Martin & Dicks-Mireaux, Louis & Poterba, James, 1983. "The effective tax rate and the pretax rate of return," Journal of Public Economics, Elsevier, vol. 21(2), pages 129-158, July.
  14. Mervyn A. King & Jonathan I. Leape, 1984. "Wealth and Portfolio Composition: Theory and Evidence," NBER Working Papers 1468, National Bureau of Economic Research, Inc.
  15. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
  16. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  17. Benjamin M. Friedman, 1985. "Crowding Out or Crowding In? Evidence on Debt-Equity Substitutability," NBER Working Papers 1565, National Bureau of Economic Research, Inc.
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Cited by:
  1. H. Naci Mocan & Stephen C. Billups & Jody Overland, 2000. "A Dynamic Model of Differential Human Capital and Criminal Activity," NBER Working Papers 7584, National Bureau of Economic Research, Inc.
  2. Geert Bekaert & Eric Engstrom & Yuhang Xing, 2005. "Risk, uncertainty, and asset prices," Finance and Economics Discussion Series 2005-40, Board of Governors of the Federal Reserve System (U.S.).
  3. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
  4. Yoichiro Fujii & Yutaka Nakamura, 2010. "Equity premium under multiple background risks," Economics Bulletin, AccessEcon, vol. 30(2), pages 933-939.
  5. Hui Guo & Robert F. Whitelaw, 2006. "Uncovering the Risk-Return Relation in the Stock Market," Journal of Finance, American Finance Association, vol. 61(3), pages 1433-1463, 06.
  6. Marjorie Flavin & Takashi Yamashita, 1998. "Owner-Occupied Housing and the Composition of the Household Portfolio Over the Life-Cycle," NBER Working Papers 6389, National Bureau of Economic Research, Inc.
  7. Tim BOLLERSLEV & Ray Y. CHOU & Narayanan JAYARAMAN & Kenneth F. KRONER, 1991. "Les modéles ARCH en finance : un point sur la théorie et les résultats empiriques," Annales d'Economie et de Statistique, ENSAE, issue 24, pages 1-59.
  8. Flavin, Marjorie & Yamashita, Takashi, 1998. "Owner-Occupied Housing and the Composition of the Household Portfolio over the Life Cycle," University of California at San Diego, Economics Working Paper Series qt89x293v9, Department of Economics, UC San Diego.
  9. Corrado, Charles J. & Jordan, Bradford D. & Miller, Thomas Jr. & Stansfield, John J., 2001. "Repricing and employee stock option valuation," Journal of Banking & Finance, Elsevier, vol. 25(6), pages 1059-1082, June.
  10. Robert B. Barsky & Miles S. Kimball & F. Thomas Juster & Matthew D. Shapiro, 1995. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Survey," NBER Working Papers 5213, National Bureau of Economic Research, Inc.
  11. Hui Guo, 2002. "Stock market returns, volatility, and future output," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 75-86.

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