Advanced Search
MyIDEAS: Login to save this paper or follow this series

Implications of Anticipated Regret and Endogenous Beliefs for Equilibrium Asset Prices: A Theoretical Framework

Contents:

Author Info

Registered author(s):

    Abstract

    This paper builds upon Suryanarayanan (2006a) and further investigates the implications of the model of Anticipated Regret and endogenous beliefs based on the Savage (1951) Minmax Regret Criterion for equilibrium asset pricing. A decision maker chooses an action with state contingent consequences but cannot precisely assess the true probability distribution of the state. She distrusts her prior about the true distribution and surrounds it with a set of alternative but plausible probability distributions. The decision maker minimizes the worst expected regret over all plausible probability distributions and alternative actions, where regret is the loss experienced when the decision maker compares an action to a counterfactual feasible alternative for a given realization of the state. We first study the Merton portfolio problem and illustrate the effects of anticipated regret on the sensitivity of portfolio rules to asset returns.We then embed the model in a version of the Lucas (1978) economy. We characterize asset prices with distorted Euler equations and analyze the implications for the volatility puzzles and Euler pricing errors puzzles.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://www.csef.it/WP/wp162.pdf
    Download Restriction: no

    Bibliographic Info

    Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 162.

    as in new window
    Length:
    Date of creation: 01 Sep 2006
    Date of revision:
    Handle: RePEc:sef:csefwp:162

    Contact details of provider:
    Postal: I-80126 Napoli
    Phone: +39 081 - 675372
    Fax: +39 081 - 675372
    Email:
    Web page: http://www.csef.it/
    More information through EDIRC

    Related research

    Keywords:

    This paper has been announced in the following NEP Reports:

    References

    References listed on IDEAS
    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.:
    as in new window
    1. Hansen, Lars Peter & Jagannathan, Ravi, 1997. " Assessing Specification Errors in Stochastic Discount Factor Models," Journal of Finance, American Finance Association, vol. 52(2), pages 557-90, June.
    2. Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
    3. Martin Lettau & Sydney C. Ludvigson, 2005. "Euler Equation Errors," NBER Working Papers 11606, National Bureau of Economic Research, Inc.
    4. Pascal St-Amour & Stephen Gordon, 2000. "A Preference Regime Model of Bull and Bear Markets," American Economic Review, American Economic Association, vol. 90(4), pages 1019-1033, September.
    5. 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.
    6. Bryan R. Routledge, Stanley E. Zin, 2000. "Model Uncertainity And Liquidity," Computing in Economics and Finance 2000 368, Society for Computational Economics.
    7. Hansen, Lars Peter & Sargent, Thomas J & Tallarini, Thomas D, Jr, 1999. "Robust Permanent Income and Pricing," Review of Economic Studies, Wiley Blackwell, vol. 66(4), pages 873-907, October.
    8. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-27, May.
    9. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
    10. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, vol. 49(3), pages 555-74, May.
    11. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
    12. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
    13. Pascal J. Maenhout, 2004. "Robust Portfolio Rules and Asset Pricing," Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 951-983.
    14. Hansen, Lars Peter & Richard, Scott F, 1987. "The Role of Conditioning Information in Deducing Testable," Econometrica, Econometric Society, vol. 55(3), pages 587-613, May.
    15. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March.
    16. Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
    17. Angelo Melino & Alan X. Yang, 2003. "State Dependent Preferences Can Explain the Equity Premium Puzzle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 806-830, October.
    18. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of security market data for models of dynamic economies," Discussion Paper / Institute for Empirical Macroeconomics 29, Federal Reserve Bank of Minneapolis.
    19. Pok-sang Lam & Stephen G. Cecchetti & Nelson C. Mark, 2000. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?," American Economic Review, American Economic Association, vol. 90(4), pages 787-805, September.
    20. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    21. Epstein, Larry G. & Zin, Stanley E., 1990. "'First-order' risk aversion and the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 26(3), pages 387-407, December.
    22. Bryan R. Routledge & Stanley E. Zin, 2003. "Generalized Disappointment Aversion and Asset Prices," NBER Working Papers 10107, National Bureau of Economic Research, Inc.
    23. Hansen, Lars Peter & Sargent, Thomas J., 2005. "Recursive robust estimation and control without commitment," Discussion Paper Series 1: Economic Studies 2005,28, Deutsche Bundesbank, Research Centre.
    24. Epstein, Larry G. & Schneider, Martin, 2003. "Recursive multiple-priors," Journal of Economic Theory, Elsevier, vol. 113(1), pages 1-31, November.
    25. Rajnish Mehra & Edward C. Prescott, 2003. "The Equity Premium in Retrospect," NBER Working Papers 9525, National Bureau of Economic Research, Inc.
    26. Manski, Charles F., 2007. "Minimax-regret treatment choice with missing outcome data," Journal of Econometrics, Elsevier, vol. 139(1), pages 105-115, July.
    27. Lars Peter Hansen & Thomas J. Sargent, 2005. "Certainty equivalence and model uncertainty," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 17-38.
    28. Segal, Uzi & Spivak, Avia, 1990. "First order versus second order risk aversion," Journal of Economic Theory, Elsevier, vol. 51(1), pages 111-125, June.
    29. Cogley, Timothy & Sargent, Thomas J., 2008. "The market price of risk and the equity premium: A legacy of the Great Depression?," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 454-476, April.
    30. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    31. 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.
    32. Raghu Suryanarayanan, 2006. "A Model of Anticipated Regret and Endogenous Beliefs," CSEF Working Papers 161, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 Dec 2008.
    33. John H. Cochrane & Lars Peter Hansen, 1992. "Asset Pricing Explorations for Macroeconomics," NBER Chapters, in: NBER Macroeconomics Annual 1992, Volume 7, pages 115-182 National Bureau of Economic Research, Inc.
    34. Charles Manski, 2003. "Statistical treatment rules for heterogeneous populations," CeMMAP working papers CWP03/03, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
    35. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:sef:csefwp:162. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lia Ambrosio).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.