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Risk Aversion, the Labor Margin, and Asset Pricing in DSGE Models

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  • Eric Swanson

    (Federal Reserve Bank of San Francisco)

Abstract

In dynamic equilibrium models, the household's labor margin has dramatic effects on risk aversion, and hence asset prices, even when utility is additively separable between consumption and labor. This paper derives simple, closed-form expressions for risk aversion that take into account the household's labor margin. Ignoring the labor margin can wildly overstate the household's true aversion to risk. Risk premia on assets priced with the stochastic discount factor increase essentially linearly with risk aversion, so measuring risk aversion correctly is crucial for asset pricing in the model. Closed-form expressions for risk aversion in DSGE models with generalized recursive preferences and internal and external habits are also derived.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 138.

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Date of creation: 2010
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Handle: RePEc:red:sed010:138

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  1. Benveniste, L M & Scheinkman, J A, 1979. "On the Differentiability of the Value Function in Dynamic Models of Economics," Econometrica, Econometric Society, vol. 47(3), pages 727-32, May.
  2. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1997. "Habit persistence and asset returns in an exchange economy," Working Paper Series, Macroeconomic Issues WP-97-04, Federal Reserve Bank of Chicago.
  3. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  4. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
  5. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  6. Glenn D. Rudebusch & Eric T. Swanson, 2008. "Examining the bond premium puzzle with a DSGE model," Working Paper Series 2007-25, Federal Reserve Bank of San Francisco.
  7. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report 280, Federal Reserve Bank of Minneapolis.
  8. John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
  9. Stiglitz, Joseph E, 1969. "Behavior Towards Risk with Many Commodities," Econometrica, Econometric Society, vol. 37(4), pages 660-67, October.
  10. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
  11. Kihlstrom, Richard E. & Mirman, Leonard J., 1974. "Risk aversion with many commodities," Journal of Economic Theory, Elsevier, vol. 8(3), pages 361-388, July.
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Cited by:
  1. Hakon Tretvoll, 2012. "Real exchange rate variability in a two country business cycle model," 2012 Meeting Papers 911, Society for Economic Dynamics.
  2. Ferman, Marcelo, 2011. "Switching Monetary Policy Regimes and the Nominal Term Structure," Dynare Working Papers 5, CEPREMAP.
  3. Jules van Binsbergen & Jesús Fernández-Villaverde & Ralph S.J. Koijen & Juan F. Rubio-Ramírez, 2010. "The Term Structure of Interest Rates in a DSGE Model with Recursive Preferences," NBER Working Papers 15890, National Bureau of Economic Research, Inc.
  4. François Gourio & Michael Siemer & Adrien Verdelhan, 2011. "International Risk Cycles," NBER Working Papers 17277, National Bureau of Economic Research, Inc.
  5. Harald Uhlig, 2010. "Easy EZ in DSGE," 2010 Meeting Papers 111, Society for Economic Dynamics.
  6. Gourio, François, 2012. "Macroeconomic implications of time-varying risk premia," Working Paper Series 1463, European Central Bank.

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