S-shaped utility, subprime crash and the black swan
AbstractI propose an S-shaped utility function of consumption which, combined with an heterogeneous agents and external habit setting, fits well the first order moments of the American financial and macroeconomic time series relevant for the equity premium puzzle in the second half of XX century. The average relative risk aversion of the agents remains in the 0-3 range. A "black swan"-kind phenomenon makes two of the 50 years considered (the two oil shocks) responsible for half the average of the stochastic discount factor, thus bringing the annual subjective discount factor to a very low level, around 0.5, which solves the risk-free puzzle. The shape of the relative risk aversion function of consumption suggests an explanation for the 2008 suprime crash akin to the breaking of waves on a beach in a lifecycle overlapping generations model.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 12122.
Date of creation: 12 Dec 2008
Date of revision:
financial puzzles; subprime crash; black swan; S-shaped utility;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-12-21 (All new papers)
- NEP-DGE-2008-12-21 (Dynamic General Equilibrium)
- NEP-HIS-2008-12-21 (Business, Economic & Financial History)
- NEP-MAC-2008-12-21 (Macroeconomics)
- NEP-UPT-2008-12-21 (Utility Models & Prospect Theory)
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